A credit score is essential for every individual to build a sound financial profile. You can get the loan products you need immediately because of your good credit scores. The possibility that you will be granted credit rises due to your efforts to improve your credit score.
Here, we will discuss everything you need to know about credit scores and how they can affect your future, ability to get loans, and job opportunities.
What are Credit Scores?
A credit score determines your credit risk, or how likely you are to pay off 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 duration of your credit history. Higher ratings show that you have previously demonstrated responsible credit behavior, which may inspire more trust in prospective creditors and lenders when evaluating a credit request.
Lenders, including banks and credit card companies, use credit ratings to determine the risk of lending money to consumers and to reduce losses from bad debt. Lenders use credit scores to decide if an applicant is eligible for a loan, the interest rate, and the credit limitations. Lenders also use credit scores to identify which clients are most likely to generate income.
Banks are not the only institutions that use credit evaluation. Other businesses like mobile phone providers, insurers, landlords, and government agencies may use the same strategies. Alternative data sources are being 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 capacity for timely bill payment, the frequency of missed payments, the number of days you pay bills beyond the due date, and the frequency of late payments.
- How much you owe is about 30% of your credit score. Factors like the overall amount owed, the kind and number of accounts you have, and the proportion of your debt to accessible credit play a role in this. If you pay your bills on time and in small amounts, your credit score may go up, but bigger balances and maxed-out credit cards will drop it.
- The length of your credit history is about 15% of your credit score. The longer you have made payments on time, the better your credit rating will be. When considering credit history, credit scoring models often consider the average age of your credit. For this reason, you might think about maintaining open and active accounts.
- Your account type is about 10% of your credit score. Having various accounts, such as credit cards, installment loans, and other loans, may help you raise your credit score.
- Recent activity on your account takes the final 10% of your credit score. Recent account openings or applications for new accounts could indicate prospective financial difficulty and reduce your score.
If you have a below 690 credit score, you might need to consider increasing it to enhance your chances of getting a loan. Also, if you don’t know your current score, you can calculate your credit score using any available online tool or visit your bank for more.
Building and maintaining great credit is a cornerstone of a successful financial life. Money Girl, Laura Adams and Rod Griffin from Experian discuss how you can manage credit wisely and raise scores instantly for free in this episode of the Money Girl podcast.
Importance of a good Credit score
A credit score above 650 is considered fair. There are numerous benefits of having a good credit score, and we shall discuss some of them below;
Lower Interest rate
One of the fees that come with getting a loan is the interest rate, and you frequently receive a rate directly correlated with your credit score. There is a high chance of you being eligible for the lower interest rates and paying less in finance fees on credit card balances and loans if you have a high credit score.
Easier approval of loans
Due to repeated rejections, borrowers with bad credit often avoid applying for new credit cards or loans. A high credit score does not ensure acceptance because lenders still take your income and debt into account. However, having a high credit score boosts your likelihood of obtaining new credit. In other words, you can confidently apply for a loan or credit card. Although getting a loan with a bad credit score is possible, you are advised to keep your credit score high.
Easier approval for a higher limit
Your credit score and salary determine your ability to borrow money. Because you’ve shown that you can repay what you borrow on time, banks are more prepared to let you borrow additional money if you have a strong credit score. With a low credit score, you might still be accepted for some loans, but the amount will be smaller.
Easier approval for rental houses and purchases
Many landlords are now using credit scores during the tenant screening process. Poor credit can seriously hurt your prospects of renting an apartment, mainly if brought on by a prior eviction or unpaid rent. A good credit score means avoiding the time and stress of looking for a landlord who will approve renters with bad credit.
Effects of Having a bad credit score on Loans and Jobs
With a bad credit score you may miss out on some loans and even job opportunities. Here are a few disadvantages of having a bad credit score;
Higher interest rates on Loans and credit cards
Your credit score indicates your chance of defaulting on a credit card or loan commitment. You are a riskier borrower than someone with a higher credit score. By imposing a higher interest rate on you, creditors and lenders make you pay for this risk.
If you are given credit with a low credit score, you will eventually pay more in interest than you would if your credit was better.
You might miss out on some Career opportunities.
Employers can obtain consumer credit reports in most states when choosing who to hire, promote, or reassign. That’s especially true if the position has significant financial obligations.
Your employer won’t see your exact credit score, but they can access your credit report and see details of your accounts with your signed permission. If found, this might affect their decision to hire you.
To hear more about credit scores – and why yours might have dropped – check out episode 599 of the Money Girl podcast below.