A credit score is essential for every individual to build a solid financial profile. You can get the loan products you need right away because of your good credit ratings. The possibility of obtaining credit increases due to your efforts to improve your credit score.
Here, we’ll discuss everything you need to know about credit scores and how they can affect your future, your ability to get loans, and job opportunities.
What are credit scores?
A credit score determines your credit risk, or the likelihood that you’ll repay your loans on time, and it’s a three-digit number ranging from 300 to 850.
Your credit score is determined by considering your payment history, the total amount of debt you owe, and the length of your credit history. Higher scores show that you have already demonstrated responsible credit behavior, which can inspire more confidence in potential creditors and lenders when evaluating a credit application.
Lenders, including banks and credit card companies, use credit scores to determine the risk of lending money to consumers and to reduce losses from bad debts. Lenders use credit scores to decide whether an applicant qualifies for a loan, interest rate and credit limits. Lenders also use credit scores to identify customers most likely to generate income.
Banks are not the only institutions to use credit scoring. Other businesses such as cell phone providers, insurers, landlords, and government agencies may use the same strategies. Alternative data sources are used by digital finance organizations, such as online lenders, to determine a borrower’s creditworthiness.
How are credit scores calculated?
Credit scores are calculated based on these five factors:
- About 35% of your credit score is based on your payment history. It represents your ability to pay your bills on time, the frequency of missed payments, the number of days you pay bills past the due date, and the frequency of late payments.
- The amount you owe is about 30% of your credit score. Factors such as the total amount owed, the type and number of accounts you have, and the ratio of your debt to available credit play a role in this. If you pay your bills on time and in small amounts, your credit score may rise, but larger balances and depleted credit cards will cause it to drop.
- The length of your credit history is about 15% of your credit score. The earlier you made your payments, the better your credit rating will be. When reviewing credit history, credit score models often consider the average age of your credit. For this reason, you might think about maintaining open and active accounts.
- Your account type accounts for about 10% of your credit score. Having various accounts, such as credit cards, installment loans, and other loans, can help boost your credit score.
- Recent activity on your account takes up the last 10% of your credit score. Recent account openings or requests for new accounts could indicate potential financial difficulties and lower your score.
If you have one below 690 credit score, you may need to consider increasing it to increase your chances of getting a loan. Also, if you don’t know your current score, you can calculate your credit score using any online tool available or visit your bank to find out more.
Building and maintaining good credit is the cornerstone of a successful financial life. Money Girl, Laura Adams and Rod Griffin of Experian explain how to manage credit wisely and instantly boost scores for free in this episode of the Money Girl podcast.
Importance of a good credit score
A credit score above 650 is considered fair. Having a good credit rating has many benefits, and we will discuss them below.
Lower interest rate
One of the fees that comes with getting a loan is the interest rate, and you often receive a rate that directly correlates to your credit score. There is a good chance that you are eligible for the lower interest rates and pay less finance charges on credit card balances and loans if you have a high credit score.
Easier loan approval
Due to repeated denials, borrowers with bad credit often avoid applying for new credit cards or new loans. A high credit score does not guarantee acceptance, as lenders always consider your income and debts. However, having a high credit rating increases your chances of getting new credit. In other words, you can confidently apply for a loan or a credit card. Although getting a loan with bad credit is possible, we advise you to maintain your high credit score.
Easier approval for a higher limit
Your credit score and salary determine your ability to borrow money. Because you’ve shown you can repay what you borrow on time, banks are more willing to let you borrow extra money if you have good credit. With a low credit score, you might still be accepted for some loans, but the amount will be lower.
Easier approval for rental homes and purchases
Many landlords now use credit scores during the tenant screening process. Bad credit can seriously hurt your chances of renting an apartment, especially if it’s caused by a previous eviction or unpaid rent. A good credit score means avoiding the time and stress of finding a landlord who will approve tenants with bad credit.
Effects of having a bad credit score on loans and jobs
With a bad credit rating, you may miss out on some loans and even job opportunities. Here are some disadvantages of having bad credit;
Higher interest rates on loans and credit cards
Your credit score indicates your risk of defaulting on a credit card or loan commitment. You are a riskier borrower than someone with a higher credit score. By charging you a higher interest rate, creditors and lenders are making you pay for this risk.
If you are granted credit with a poor credit score, you will end up paying more interest than if your credit was better.
You might miss some career opportunities.
Employers can obtain consumer credit reports in most states when choosing who to hire, promote or reassign. This is especially true if the position involves significant financial obligations.
Your employer won’t see your exact credit score, but they can access your credit report and see your account details with your signed authorization. If found, it could affect their decision to hire you.
For more on credit scores — and why yours may have plummeted — check out episode 599 of the Money Girl podcast below.