Credit Score

I’ve always been competitive growing up and as a young adult, one of the things I enjoyed competing with others was my credit score. I always had a pretty high credit score that I would brag about until I hit a hard point in my life where I was financially struggling to keep up with my lifestyle. Then my credit score slowly started to drop lower and lower. At that time, I decided to study financial literacy and learned the expression “cash is king”. I began to stay away from using credit cards or private loans and only dealt with the cash I had available to me from my paychecks. After a number of grueling years with a strict budget, I was able to pull myself out of some deep debts. So, what exactly is the purpose and benefits of credit? From having financial struggles, I now had PTSD with credit cards and debt. With this fear, I don’t want to lose sight of its advantages and how I can leverage it for my benefit. I know I just need to be disciplined to be able to use it properly for my gain.

What is the purpose of a credit score?

The purpose of a credit score is to provide a quick and standardized way for lenders, landlords, and other entities to assess your creditworthiness - essentially, your ability and likelihood to repay debts on time. It serves as a snapshot of your financial behavior and reliability.

Key Purposes:

  1. Risk Assessment for Lenders

    • Helps lenders evaluate the risk of lending you money or extending credit. A higher score indicates lower risk, making it more likely they'll approve your application.

  2. Decision-Making Tool

    • Credit scores simplify the decision-making process for banks, credit card issuers, and other creditors by providing a numerical summary of your financial history.

  3. Standardized Metric

    • Provides a uniform measure to compare potential borrowers, ensuring fairness and consistency across applicants.

  4. Encouraging Financial Responsibility

    • Serves as an incentive for individuals to manage credit responsibly by rewarding good financial habits with better scores and benefits.

  5. Determining Terms of Credit

    • Influences the interest rates, credit limits, and repayment terms you might receive, with higher scores leading to more favorable terms.

  6. Non-Lending Uses

    • Used by landlords, insurers, and even employers (in some cases) to gauge your reliability and financial responsibility.

Credit scores play a central role in shaping financial opportunities and decisions in a modern economy.

Why is a credit score important?

A credit score is important because it reflects your financial trustworthiness and affects various aspects of your financial life. 

Here's why:

  1. Access to Credit

    • Lenders use your credit score to decide whether to approve your loan or credit card application. A higher score increases your chances of approval.

  2. Interest Rates and Loan Terms

    • Higher credit scores typically qualify for lower interest rates and better loan terms, saving you money over time.

  3. Housing Opportunities

    • Landlords often check credit scores during the rental application process. A good score can make it easier to secure a lease.

  4. Employment

    • Some employers review credit scores for positions that involve financial responsibility.

  5. Insurance Premiums

    • Insurers may use credit scores to determine premiums for auto or homeowner’s insurance, with better scores often leading to lower rates.

  6. Financial Flexibility

    • A strong credit score gives you access to larger lines of credit or higher loan amounts when needed for significant purchases or emergencies.

Maintaining a good credit score involves timely payments, keeping debt levels low, and managing credit responsibly.

Equifax, Experian, and TransUnion

What are they and what do they do?

Credit bureaus collect information about your financial habits, such as payment history and credit usage, to compile a credit report.

  • Equifax (https://www.equifax.com/)

  • Experian (https://www.experian.com/)

  • TransUnion (https://www.transunion.com/)

How to get a free credit report

You can request a free credit report from each of the three bureaus once a year: 

  • Online at AnnualCreditReport.com 

  • By calling 1-877-322-8228 (TTY: 1-800-821-7232) 

  • By mailing the Annual Credit Report request form to: Annual Credit Report Request Service, PO Box 105281, Atlanta, GA 30348-5281

Why it's important

Reviewing your credit report can help you: 

  • Correct any errors in your credit history 

  • Protect your credit identity

You can have a credit score with only one of the three bureaus if your lenders only report to that bureau. Lenders are not required by law to report your credit activity.

What determines a credit score?

A credit score is determined by a variety of factors that reflect your creditworthiness and financial behavior. The most common scoring models, like FICO and VantageScore, use the following key factors:

  1. Payment History (35%)

    • What it measures: Your track record of paying bills on time.

    • Impact: Missing payments, late payments, or defaults can significantly lower your score.

    • Tips to improve: Always pay at least the minimum amount due on or before the due date.

  2. Credit Utilization (30%)

    • What it measures: The amount of available credit you’re using, expressed as a percentage.

    • Impact: High utilization (e.g., using more than 30% of your credit limit) can hurt your score.

    • Tips to improve: Aim to keep your credit utilization below 30%, ideally below 10%.

  3. Length of Credit History (15%)

    • What it measures: How long your credit accounts have been active.

    • Impact: A longer credit history can improve your score.

    • Tips to improve: Keep older accounts open and in good standing.

  4. Credit Mix (10%)

    • What it measures: The variety of credit accounts, such as credit cards, loans, and mortgages.

    • Impact: A mix of different types of credit demonstrates the ability to handle diverse credit responsibilities.

    • Tips to improve: Use a combination of credit types responsibly, but don't open new accounts unnecessarily.

  5. New Credit (10%)

    • What it measures: The number of recent credit inquiries and newly opened accounts.

    • Impact: Too many recent inquiries or new accounts can signal financial instability.

    • Tips to improve: Avoid applying for multiple credit accounts within a short time.

Additional Considerations

  • Negative Items: Bankruptcy, foreclosures, and accounts in collections can severely damage your score.

  • Closed Accounts: Closing an account can affect your score by reducing your available credit and shortening your credit history.

  • Disputes or Errors: Incorrect information on your credit report can also impact your score, so regularly review your credit report for accuracy.

Tips for Maintaining or Improving Your Credit Score

  1. Check your credit reports regularly for errors.

  2. Pay bills on time.

  3. Keep your credit utilization low.

  4. Avoid unnecessary credit inquiries.

  5. Build a diverse credit profile over time.

Published: Jan 2nd, 2025