Understanding Credit Scores

Credit scores are vitally important in the financial world, they make the business and finance world go round. Therefore, it is crucial that even if you do not intend on using credit, you understand how credit scores work, because you never know when you might need it. 

Credit scores are used for loan approval, this includes personal loans, auto loans, mortgages, and so on. So, knowing what your credit score is, how it works, what influences it and how it will influence you, is very important. 

So, where do we start with credit scores? Well, first, what are they?

What Are Credit Scores?

Credit scores are number based figures which will denote the collective information on your credit report. Their numbers usually range from 300 to 850, and where in this range your score falls will represent how risky of a borrower you are to lenders. 

It basically tells lenders how likely you are to pay back to them what you borrowed. It can affect approval for loans and any type of credit. This number will also determine terms offered and the interest rate you get. 

Are There Different Types Of Credit Scores?

Credit scores are used by lenders to determine how creditworthy you are and how trustworthy you are. Your personal score is built based on your credit history, and a decent score is very important to having good financial health. 

The higher the score is the less of a risk you will be. There are generally two types of credit scores. 

First there are generic scores which are used by most lenders and businesses to get a general idea of credit risk. You are able to access your generic score using the same formula as all credit reporting agencies. 

There are also custom credit scores which are made for use by specific lenders. They will rely on other information as well as credit reports. They will look at account history and so on. 

These will be unique to specific businesses and can be used by credit unions and so on. This is more specific to mortgage lending and auto lending.

What Factors Influence Your Credit Scores?

There are several factors which can shape your overall credit score. These factors can be anything from total debt, to late payments, the age of your accounts, and what types of accounts you have. 

These things will affect your score in different ways upon calculation, and they can also tell you what things in your credit history need to be addressed for you to become more creditworthy. 

Monitoring your credit can help you to keep a closer eye on how these factors are influencing your score and how you can work your accounts, and credit to improve your credit score and be more attractive to lenders. 

Why Do Lenders Need To Use Credit Scores?

Long before credit scores became a thing, lenders had to look over the physical credit report of every applicant to get an idea of whether or not they were responsible enough to grant them credit. 

It was a very time consuming process, which could lead to mistakes, biases, and let lenders make decisions that actually were not so focused on the applicant’s ability to pay back a debt. 

Having the current way of doing credit scores and reports allows lenders to assess the risk an applicant carries in a more fair and reasonable manner. 

This is because credit scores are consistent and more objective. They only reflect how likely you are to repay a debt based on your current status of credit and the history of your credit and nothing else. 

This means no biases can be made, and mistakes are much less likely to occur.

How Do Credit Scores Work?

Credit scores are able to significantly affect your financial life, playing a very important role in lenders decisions about whether or not to lend you credit. If your score is below 640, you might be viewed as a subprime borrower, and interest will likely be charged at a higher rate. 

You may also get shorter terms for repayment, or you may need a cosigner to borrow if your credit score is low. 

However, if you have a score over 700 it is viewed as very good and you will likely get a much lower rate of interest, therefore leading you to have to pay much less over the whole life of the loan. 

Scores which are over 800 are seen as excellent, and you will often get the best rates and fees with a credit score like such. 

While every lender will define their own ranges for a credit score, many lenders will use FICO, or something at least very similar to FICO, to determine a credit score. 

With FICO, credit scores look something like this: 

Improving Your Credit Score

When information gets updated on your credit report, your score will change, and it can fall or rise depending on what new information is applied. 

This means that by applying good credit and financial behaviors, you can increase your credit score overtime. 

There are many things you can do to improve your score. 

For one, you can ensure that you always pay bills on time. If you pay bills on time for 6 months you are sure to notice a difference in your credit score as it starts to improve. 

You could also increase your line of credit. If you have a credit card account, you can inquire about an increase. With an account in good standing you should be granted this. However, you should not be spending this amount, you want to maintain a low rate of utilization. 

Keeping credit card accounts open is important, even if you do not use a credit card, it is better to just stop using it, rather than closing it. Closing it could actually hurt your credit score!