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Lenders give credit to creditworthy individuals, and they know this through your credit score. Credit scores are numbers ranging between 300-850, depicting a consumer’s creditworthiness. A higher credit score shows potential lenders that you have lower default risk, thus increasing your chances of qualifying for a loan with favorable terms. Your credit score depends on several factors, including the number of open accounts, credit history, repayment history, total debt levels, and much more. The credit score is valuable for lenders in determining one’s ability to pay the loan promptly.
The credit score also depends on the scoring model, with the common ones being FICO and VantageScore. FICO is the most utilized credit scoring model, used by several financial instructions. Nevertheless, let’s take a look at VantageScore and see its difference from FICO.
VantageScore is a product of three main credit bureaus: Equifax, TransUnion, and Experian, to help them predict the likelihood of a borrower repaying the money. In the past, VantageScore used a different scale than FICO; however, recent revisions have harmonized its ranking with the FICO scale of 300-850. It is free, and lenders are beginning to warm up to it in the market. Unlike FICO, VantageScore does not use percentages but the level of influence. For instance, payment history is considered highly influential, the type and age of your credit are regarded as highly effective, and the total credit balance as moderate.
The difference between VantageScore and FICO
- VantageScore requires a shorter duration (one to two months) of opening an account to establish your credit score, while FICO needs your six months credit history. This means that individuals with limited credit history can get a credit score with VantageScore.
- VantageScore also ignores paid collection that previous FICO took into account. However, the upcoming FICO models also intend to overlook paid amounts.
- VantageScore gives more weight to late mortgage payments than other debts, whereas for FICO, all late debt payments injure your credit score in equal measure.
- VantageScore allows only 14 days for rate-shopping for a mortgage or car, while FICO allows 45 days.
Credit Score Ranges
Though these credit score models vary, they are similar in their measurement scale. The credit score scale range from excellent to poor, with 300-579 showing poor credit score, 580-669 signifying fair credit score, 670-739 is a range for good credit score, 740-799 indicating very good, while 800-850 depicting excellent credit score.
Credit card companies, banks, and car dealers often utilize these scores in deciding to offer your credit.
Why Are Credit Scores Important?
People strive to improve their credit scores’ daily to attain higher values. This is because a higher credit score would mean favorable credit terms when acquiring credit. These terms may include lower interest rates and payments on the account. However, since potential borrowers have varying credit and financial situations, lenders may not purely rely on credit scores when granting loans. Other factors like income are also considered before a lender grants credit to you.
The focus of credit scores by lenders may also vary depending on the industry. For example, auto lenders may use credit score models that emphasize repayment history. Some lenders and creditors may also use a combination of credit scores from the three national credit bureaus since not all credit reports to them. This allows lenders to get an accurate score of a potential borrower.
How do Credit Scores Work?
One’s credit score plays an essential role in your financial life, helping you acquire credit. Individuals with a credit score below 640 are often considered subprime borrowers. Most lenders will charge higher interest on subprime mortgages for compensation in carrying more risk. Additionally, creditors may require a co-signer or a shorter repayment term for anyone with a low credit score.
On the other hand, potential borrowers with a 700 and above credit score are viewed as good and, as such, may qualify for credit at a lower interest rate over the loan life. A credit score above 800 marks is regarded as excellent, thus allowing credit with better terms since they have lower default risks.
In a nutshell, one’s credit score is a statistical analysis of their creditworthiness, directly impacting the amount they will pay as interest for any credit extended to them. A credit score could also determine the amount of initial deposit you will pay before obtaining cable service, a smartphone, renting an apartment, or paying utilities. The beauty is that you can renegotiate loan terms, such as interest rates, when your credit score improves.
Components of a Credit Score
The FICO credit score is subdivided into five major components weighted differently. These components include payment history, weighted at 35%, the amount owed or debt burden weighted at 30%, length of credit history weighted at 15%, types of credit, and inquiry into credit record weighted at 10%. Let’s examine how each of these components affects the overall credit score.
1. Payment History
Payment history is an essential component in the FICO credit report, contributing to 35% of your credit score. Lenders and creditors use it as a sure way of knowing your ability to pay new debts. A debt record marred with negative information would send a wrong signal to financial institutions that it is challenging for you to meet your debt obligation. Adverse credit history may also tell potential lenders that you are not cautious when making financial decisions.
Payment history entails your credit card and loan installment history, although loan repayment takes precedence over credit cards. This means that if you want to maintain an excellent credit score, you should make consistent on-time payments.
2. Late payments
Many borrowers face a common problem under payment history called late payments. People experience late payments either because they forgot or they are struggling to make ends meet. Whatever the case, late monthly payment for your loan or credit card balance will negatively affect your credit score. The length of lateness also has a bearing on how low your FICO score plummets, with longer delays to pay inflicting the worst blows on your credit score. Do not ignore small amounts of late payments since they can damage your credit score as massive amounts.
It is advisable to maintain a few credit cards and accounts to help you avoid late payments. If you have multiple credit cards, the chances of forgetting them are high, and it may damage your credit score even if you are responsibly making payments on other accounts.
3. Accounts Owed or Debt Burden
This is another component of credit score, entailing the total amount of debt you owe, the type of loans, and other qualitative indicators that have a bearing on your credit profile. Lenders often examine your total debt and how it is broken across various loan types to determine your ability to manage existing debt.
The FICO score does not necessarily consider higher or lower amounts as a measure of a better credit score. The calculation will be done depending on several factors, including payment history. For instance, a person may have huge debts but with long and clean payment history, signifying that they are financially stable. Lenders would assume that any additional credit will be a financial obligation they can handle with ease. On the other hand, a person with a similar debt profile plagued with recent payment problems raises a red flag for potential lenders. Creditors may begin to reason that such an individual faces financial difficulties and that even small additional loans would be risky. When discussing debt burden, it is crucial to consider credit utilization as a factor that propels credit score.
4. Credit Utilization
Credit utilization is an essential piece in determining your FICO score. It measures the total debt on your credit card by considering the limit allowed on those cards. A lower credit utilization means you will have an insufficient balance than you could have on the card. This is better for your credit score as it indicates good financial planning.
A good debt limit ratio may help you when you are considering canceling an existing credit card. Even if you do not use it, maintaining a credit card will improve your credit utilization figures so long as the cards have no fees on unpaid balances. Therefore, requesting an increase in the credit limit on your existing cards could improve your credit score. Credit utilization helps lenders determine the level of wiggle room you have with your finances. If you only use a smaller percentage of the credit limit, the credit company believes you can handle additional debt or credit, not putting you at significant risk.
5. Length of Credit History
Credit history is the duration your various credit accounts have been operational. It is the average amount of time that all your account has and the length of the oldest open account. This component helps you to demonstrate how other factors of the score benefit your creditworthiness. Older credit accounts and more extended credit history provide potential lenders with a larger time frame from which they can accurately judge your credit behavior and finances. The longer the years of credit history, providing adequate information about a person, the higher the credit score. Canceling a credit card could impact your credit history negatively, hence the need to weigh on this decision. If you have built a substantial credit history with several credit cards, you could decide to cancel the first credit card. The cancellation could be reasonable if the first credit card does not make the best economic sense. However, some analyst advises leaving that credit card dormant instead of canceling to increase your overall debt limit ratio.
6. Type of Credit
The type of credit contributes 10% to the FICO credit score, considering various kinds of credit or debt used. Your credit accounts can be categorized into mortgages, credit cards, installment loans, and consumer finances, positively indicating your credit score. Lenders are interested in individuals with a history of exposure to various credit types. This tells creditors that a consumer is conversant with available financial products and can adequately manage them. Lenders are often cautious with customers having narrower credit exposure. Factors such as length of credit history and type of credit component represent your credit sample size and future behavior. This representation will tell potential lenders a consumer’s behavior with an extensive range of credit in the future.
7. Recent Inquiry into Your Credit History
Recent inquiries or searches into your credit profile due to a new loan you are applying for is the last component of the FICO score. The higher the number of times lenders request your data, the lower your credit score is dragged. However, the FICO score does not make several adjustments while evaluating the number of inquiries made on your profile. Since individuals searching for auto loans, mortgages, and education loans may make several applications to different financial institutions, all the searches conducted by these institutions within two weeks to one and a half months of each other is regarded by FICO as a single search. The search takes 30 days before reflecting on your credit score, resulting in a fair evaluation during rate shopping. It is advisable to compress the loan search period to minimize the impact on your overall credit score.
Sometimes inquiries can be made on consumers’ credit scores for reasons different from requesting a loan. For example, checking your credit or a requirement by your employer could lightly affect your credit score. These are not hard inquiries on your profile; therefore, they may not appear on the credit report, often used for evaluation.
How to Improve Your Credit Score?
Since your credit score is a crucial indicator of your financial health, it is vital to consider it carefully. Potential lenders are using it to gauge how responsible you are with credit. A higher credit score will guarantee your chances of acquiring a loan or credit with better terms. Fortunately, you can do several things to improve your credit score, albeit it will take time and patience. Without further ado, let’s consider a detailed guide on how you can achieve a better credit score with ease.
Review Your Credit Reports
It is essential to review your credit reports to discern what is working in your favor and what is contrary. One way to have a clear view of these facts is by examining your credit history, as shown in the free report. You can retrieve a free copy of your credit report from any renowned national credit bureau: Experian, Equifax, and Transunion. However, the free copy is acquired once every year through the AnnualCreditReoprt.com website. After receiving this report, you do well to examine the details. This will help you know what is hurting your credit score and any discrepancies.
Components of a credit report that positively affect your credit score include low balances on your credit cards, on-time payment history, and few new credits that lead to minimal hard inquiries on your credit profile. On the other hand, missed or late payments, collections, high credit card balances, and judgments can easily send your credit score on a downward spiral. To improve your credit score, you want to examine these credit report components to establish what needs to be corrected.
Do not miss payments
Since most lenders prefer the FICO credit score, you want to give additional attention to your payment history because it has a 35% contribution on your credit score-the highest of all the components. If you pay your debts when they are due, it will work in your favor. Look into your credit report and arrange your debts from the most insignificant to the most significant, and use the snowball method to pay off these debts.
If you have many credit cards and are prone to forgetting some of these debts, you do well to keep a diary of each debt balance and due date. This way, you will avoid late payments and the costs that come with them. Other tips to help stay on top of your credit payment are:
- Establish a digital or paper filing system to help you keep track of your monthly bills.
- Set due-dates alerts on your phone to remind you of when your next bill needs to be paid.
- You can also automate bill payments from your bank so that each time your salary hits your account, it is automatically deducted to pay your debts.
Additionally, you could decide to charge all your monthly bills to a single credit card, assuming your will clear all the balances at the end of the month. Such a move will reduce the interest charges on your account and improve your credit score. This method will also simplify your bill payment and contribute to an on-time payment on your credit report.
If you are experiencing a challenge with affording a bill, contact the credit card issuer and discuss the challenges with them. You might not see an immediate impact of on-time payment, but failure to pay will send collections to your door, causing a dip in your credit score.
Aim for 30% or Less Credit Utilization
Credit card issuers often set a level of credit extended to you that you can not exceed with the card. The portion of that credit limit that you utilize at a particular given time is called credit utilization. It is the second in value after payment history in the FICO score calculations of your credit score.
To improve your credit score, you should monitor your credit utilization and pay all your credit card balances every month. However, sometimes, you may find it hard to meet your monthly balances because of financial challenges fully. If that is the case, you could maintain an outstanding credit card balance of 30% or less to improve your credit score. The goal is to reduce credit utilization to 10% or less, and you will see your credit score improving.
Furthermore, you can utilize the alert features to warn you when your credit balances are getting out of control. These alerts will help not to add in more debts when your credit utilization ratio is getting higher.
You can ask the credit card issuer to increase your credit utilization ratio by requesting them to increase your credit limit. An increase in the credit limit while credit balances remain the same will help your credit utilization and improve your credit score. Most companies will approve your credit limit request through an online application if your annual household income improves. Approval for a higher limit can be quickly approved if you meet the set requirements. Some credit card issuers allow you to make these requests through the phone.
Reduce or Avoid New Credit Requests and Hard Inquiries
Inquiries made on your credit history can either be soft or complex, depending on the purpose of the investigations. A soft inquiry could include allowing a potential employer to check your credit, checking your credit to know what to improve on, and reviews done by financial institutions that you are already conducting business with. Credit card companies can also make a soft inquiry into your credit history when they intend to send you pre-approved credit offers. These inquiries do not affect your credit score.
However, hard inquiries can negatively affect your credit score between two months to two years. Credit card issuers will also conduct hard questions on your credit history if you request a new credit card. Expect a similar treatment when applying for an auto loan, a mortgage, or any form of new credit. An occasional hard inquiry will not have much effect on your credit score, but frequent queries over a short period can throw your credit score off balance. Banks and financial institutions will reason you are applying for several credits because of financial difficulties; therefore, more considerable risk. Individuals that want to improve their credit score will avoid requesting new credit.
Fully Utilize a Thin Credit File
A thin credit file shows that one does not have good credit history and that the credit report can not generate a credit score. Most people in the United state face this problem, avoiding debt, thus having no natural credit history. Nevertheless, you can take some practical steps to flatten a thin credit file and improve your credit score. Some of these steps include:
Experian Boost- This program collects all relevant financial data, generally excluded from a credit report, including utility payments and banking history, and includes them when calculating your FICO credit score. Experian offers this for free for those with limited or no credit history, showing their ability to pay other debts quickly.
UltraFICO- UltraFICO is similar to Experian Boost program as it utilizes banking history to construct your FICO score if you do not have other credit elements. It will consider things like maintaining a bank account over a long time, savings cushion, avoiding overdrafts, and paying your bills on time using your bank account.
Use of Rental Kharma and RentTrack- These tools can create a credit score for renters. If you have an excellent on-time rent payment, some creditors may use these records as a basis for extending your credit. Rental Kharma and RentTrack often report a renter’s monthly rent payments to the national credit bureaus, which will improve your credit score. However, the FICCO Credit score does not consider rent payments; it only affects the VantageScore credit score. You should also remember that some rent reporting organizations will charge a fee to submit your details to the bureaus; therefore, consider the points to know what you are paying for and the services you are getting. Perch is the new baby in the rent reporting industry. It is a mobile app, that reports rent payment records to credit bureaus freely.
Maintain The Old Accounts As You Deal with Delinquencies
The credit age also determines the FICO score, showing the length of time you have operated your credit accounts. Most lenders value potential borrowers with an older average credit age than those with a relatively shorter credit age. Therefore, keep them open if you have old credit accounts you have not been using for a while. This is especially important if you have a credit balance on those cards. If you close a credit card with a balance, you would lower your credit level and increase your credit utilization ratio. The result would contribute to a lower credit score.
Furthermore, if you have charge-offs, delinquent, or collection accounts, you do well to take corrective measures and resolve these. For instance, if you have a credit card account with late or missed payments, sort these due amounts and set up a plan to make on-time payments in the future. This way, you improve your payment history for future reference.
With collection accounts and charge-offs, you could consider the right course of action, whether to pay them off in full or present a settlement offer to your creditor. Remember that newer VantageScore and FICO credit scoring models give less consideration to paid collection accounts. Nevertheless, paying your charge-offs and collections would modestly improve your credit score. Also, to keep in mind is that some negative account information, such as bankruptcy, can negatively affect your credit score for up to ten years.
Consolidate Your Debts
Those having several outstanding debts could take advantage of a debt consolidation loan from a credit union or bank and pay off all debts. Your financial institution will pay off all your existing credit balance, allowing you to have one loan to handle, probably with a lower interest rate. Debt consolidation could help you pay your debts faster, which will enhance your credit utilization ratio and credit score. Similarly, you can decide to consolidate several credit card balances using a balance transfer credit card, especially during their promotional periods when they have 0% interest on the balances. Nevertheless, you should consider the balance transfer fees because most credit issuers reap by raising the transfer costs by 3-55 of the amounts you are transferring.
Track Your Credit Through Credit Monitoring
Credit monitoring is one easy way of examining how your credit score improves over time. You can observe how your action is impacting your credit score for the better or, the worse. Fortunately, most of these services are free, helping you monitor the dynamics of your credit report, including changes in the new accounts and paid-off accounts. Additionally, credit monitoring services provider with a credit score from one of the national bureaus: Trans Union, Equifax, and Experian with monthly updates.
The best credit monitoring services will also protect your identity from potential theft and fraud. They will notice a new card in your report and provide you with an alert. If you are not aware of such a credit card, you can notify the credit card company about the suspected fraud that would damage your credit score.
Additional Ways to Improve Your Credit Score
Apart from the ways explained above, you can also improve your credit score by taking practical steps.
Avoid Changing Homes
Sometimes this may not be easy to accomplish, but if you can stick to one for a long time, it can positively impact your credit score and trust from lenders. Frequent movements show a level of uncertainty and instability, making lenders believe it may be challenging for you to pay rent. This would mean that you possess a higher risk of default and may not qualify for a good loan or qualify for one with unfavorable terms.
Acquire a Credit Builder Card
A credit builder card can also significantly improve your credit score for those looking for ways to improve their ratings. A credit builder card has high-interest rates and low spending limits and could cause your credit score to drop initially. However, in the long run, it will help improve your credit score. Remember to use these cards for small amounts every month; otherwise, you could increase your interest rates with extensive credits. Ensure you make timely repayments on the amount owed in these cards to avoid increased interest on late payments.
Benefits of Improved Credit Score
A better credit score means that lenders and credit card companies consider you a lower risk; thus, you are likely to qualify for a loan. A higher credit score also signifies a history of responsible credit management, with on-time repayments of extended credit. The benefits include:
- Improved chances of loan, mortgage, and credit card approval. You will also have the opportunity to choose from a pool of credit providers, meaning you will choose the one with the most favorable terms.
- Since lenders believe you are lower in risk, they may offer you lower interest rates on credit cards and loans, making borrowing cheaper.
- Auto insurance also considers credit scores and will provide a better rate for individuals with higher credit scores. A lower credit score often attracts additional rates besides insurance premiums, something you will avoid with an improved credit score.
- You can qualify for a higher credit limit with a higher credit score, meaning you could borrow a massive amount of money. This will enable you to achieve various financial goals faster.
How Long Will It Take You to Improve Your Credit Score?
This question does not have a direct answer since it is dependent on several things. However, one thing is clear; you will not improve your credit score within hours or a few days. Several information sources that affect your credit score will take weeks to reflect on your credit report. You will have to wait until this positive information is included in your report before you begin to see a change in your credit score. Additionally, you may have to wait for any new accounts you created to mature within a few months before you start to see how they are helping your credit score.
Another factor determining how fast your credit score climbs is regular on-time payments that will boost your credit history. You want to shun the habit of late or missed payments, court judgments, and defaults since these may taint your credit report for as long as six years.
What to Do if You Have Fallen Victim to Credit Fraud
Credit frauds include identity impersonation, where one acquires a credit card with your credentials and uses it without your knowledge. Such an act could negatively hit your credit score. Nevertheless, there are steps you can take to correct this situation.
If you notice on your credit file “Victim of Impersonation” notice, you know Cifas has marked your account as prone to fraud. Lenders often put Cifas markers on the credit files when they believe that some people have attempted to steal your identity to acquire a loan. The law requires that lenders report such cases shown in your credit files. A Cifas marker can stay in your file for 13 months, warning future lenders of your vulnerability to fraud or that you have been a victim in the past.
Fortunately, having a Cifas marker has no bearing on your credit score and does not impact your ability to take out credit. However, this record could cause you all sorts of problems if you are an automatically processed credit card like a card for store finance.
Some Less Obvious Situations that Can Affect Your Credit Score
We have already established some apparent factors that impact a credit score, including payment history, credit utilization, hard inquiry on new credit, and credit age. However, several subtle factors also have a bearing on your credit score and will need consideration. These factors include:
1. Business Cards
As an employee or a small enterprise owner, you do well to consider how you handle your business credit card lest it negatively affects your credit score. Business owners bear the highest liability as primary card owners since their actions could produce the worst hit on their credit. Though some credit cards like Capital One® Spark® Cash for Business allow business owners to add employee cards without a charge conveniently, they run the risk of paying debts accrued by authorized users.
2. Unpaid Health Bills
One of the most crucial determinants of one’s credit score is payment history. It is affected by loan bills, credit cards, and other unpaid bills, such as medical bills, often sent to debt collectors after a considerable period.
3. Cell Payment Plan
Your credit report may also have any installment loans you have accrued when buying items on hire purchase terms. Therefore, if you long for that latest iPhone and choose to pay it with a one and half payment plan, ensure that you pay your monthly installments on time; otherwise, this would negatively reflect your credit score.
4. Withholding Utilities and Rent
Suppose you refuse to pay utilities and rent or end a lease agreement before time without paying the stipulated fine. In that case, you could be reported to national credit bureaus, thus negatively affecting your credit score. Though utility companies and landlords do not send your payment history to the bureaus, be sure they will report unpaid bills.
5. Unpaid Parking Tickets
Many people served with parking tickets may fail to pay them on time; however, any unpaid fees and fines can ruin your credit score in the long run. This is because failure to pay your ticket on time may result in them being sent to collections.
6. Overdue Library Books
Libraries often charge a fine for late book returns. If you fail to pay these fines, the library may be forced to send your records to collection; hence negatively impacting your credit score.
7 Loan Co-signing
If you guarantee a loan for a friend or a family member or when they are opening a credit card, and they default in paying, your credit score would be affected in three ways:
- Their late or missed payment could reflect on your credit report
- The size of the loan or account balance could increase your credit utilization rate
- A new inquiry could hit your credit report.
Your credit score is valuable when acquiring a loan, an insurance policy, or even employment. A higher credit score gives potential lenders confidence that you are less likely to default, meaning you can qualify for credits and loans with improved terms. Therefore, improving your credit score is vital for your financial stability. You can improve your credit score by reviewing your credit reports, consolidating your debts, utilizing credit monitoring services, keeping your old accounts open, avoiding new credit requests, reducing credit utilization, and making on-time payments