| Posted in Financial Literacy
What is a credit score?
Credit scores have a wide array of uses in our everyday life. We hear about them in commercials, applying for loans, getting an apartment, a house, or a car. They are, simply put, a constant presence in our daily existence. And yet there is a lot of confusion and questions about what exactly a credit score is and how it’s determined.
A credit score is a number between 350 and 850 that is used by creditors to analyze your past payments and credit history. This number helps creditors, such as banks, determine how likely you are to make payments on a loan. A higher credit score makes it easier to obtain a loan, get lower insurance rates, rent an apartment, and other financial tasks requiring borrowing and paying money.
Since a higher score makes it more likely to get requested loans and good rates, it makes sense that a person would be better off optimizing their score and aiming for the high end. While it can take time and perhaps be difficult to raise a credit score, it certainly isn’t impossible. In fact, there are many ways to help improve it.
How to maintain (and improve!) your credit score
Always pay your loans on time
This might seem like a trivial thing, but it’s very important and can work wonders for both your credit score and your budget balancing. Make your payments on time, every time, for any loans or bills you have. A helpful way to manage this is by setting up electronic and automatic payments so you can set it and forget it while still making your payment obligations.
Don’t max out your credit or get too close to your credit limit
One of the worst ways to get into unmanageable debt is by acquiring lots of credit cards and maxing them out. While making regular and full payments can help alleviate this problem, if your rate of spending is very high and you’re using numerous cards maxed to their limits you can quickly run into a problem. A good rule of thumb is to keep your use of credit at no more than 30% of your total credit limit (across all cards).
Keep in mind: with the 30% rule, closing out a card and transferring credit to more cards with lower balances can have a negative impact on your credit score. Keep an eye on what cards you have open and how much you’re accruing on each of them, and how that factors into your total credit usage.
Be careful what cards you sign up for, and how long you keep them
Formulas for figuring credit scores don’t only look at payments and percentage of credit used – they also look at recent credit activity. For example, someone acquiring several new credit cards quickly might have life factors negatively affecting their ability to make payments in the future and on time. While store and large-bank credit cards can be easy to obtain for fast credit, taking out several of them at once and for no financial necessity can hurt your score. Only take out a new credit card when you very much need it and have the financial ability to continue your payments on time.
Similarly, a long history of responsibly paying off accruals on a credit card shows a consistent financial history that can benefit your score. With more information and a longer history, there is more good data for the rating agency to determine your payment habits.
Do your due diligence
No agency is perfect, and no organization will ever get it 100% right. When you receive your credit score from a rating agency (such as Experian or Equifax), go through the rating factors closely and look for errors. Sometimes the rating can improve simply by double-checking basic information, such as names, dates, and other information. There are plenty of things to look for, so take your time and do your homework. If needed, dispute errors on your credit report.
Credit where credit is due
For those new to personal finance and credit scores, this can seem like a lot of work. But the effort is well worth it when you pursue a loan later. A higher credit score can mean the difference between a good rate and a great one. Setting yourself up for a great financial situation months, even years, down the road is a proven formula for success.