What You Should Know About Your Credit Score
A key element that separates the rich from the poor is that the rich can invest and leverage other people’s money at a low-interest rate for their benefit.
On the other hand, the poor and the middle class often just use their own money or borrow money at an exorbitant rate from credit card companies or predatory organizations such as loan sharks.
There is a reason why people constantly emphasize the important it is to have a credit score and that you should start early when it comes to building credit.
To help you be successful financially, you need to understand:
- What is a credit score?
- When do you need your credit score?
- How is it calculated?
- How to improve your score?
What is a credit score?
Your credit score is a number that represents your creditworthiness.
It is based on information in your credit report and is used by lenders to determine your risk as a borrower. A high credit score indicates to lenders that you are a low-risk borrower.
As a result, you are more likely to be approved for loans, credit cards, and mortgages at favorable terms and lower interest rates if you have a good credit score.
A good credit score can also help you save money over time by qualifying you for lower interest rates and better loan terms.
Therefore, having a good score is essential for obtaining credit and achieving financial stability.
This post will cover everything you need to know about your credit score, including how it is calculated, what factors affect it, and how to improve it.
When do you need your credit score?
It is important to start building your credit score as early as possible.
In the early stages of your financial journey, you will need to understand what your credit score is because it’ll impact which credit cards you qualify for. Later on, in life, your credit score will be necessary for you to get car loans and mortgages.
Having the ability to get loans and borrow money will allow you to have so many more opportunities to build wealth. This is because loans will allow you to leverage other people’s money to buy a property and make investments.
I started my credit journey in 2019 when I applied for my first credit card at the age of around 21. Looking back, I’m super grateful that I took the first step toward building my credit at a relatively young age. Because now, I’ll be able to show proof that I am a trustworthy client when I need to start taking out loans for investments.
My recommendation would be to first understand the credit card best practices, and then apply for a credit card as soon as you turn 18 so you can start your credit journey early and slowly build up your credit over the years.
How is it calculated?
There are a couple of different ways your credit score is calculated. 3 credit bureaus in the United States collect your credit information to calculate your credit score. The 3 credit bureaus are: Transunion, Equifax, and Experian
The most commonly used credit score is the FICO score, which ranges from 300 to 850. The score is calculated based on the following five factors:
Different Contributing Factors:
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- Payment History (How Many Payments You’ve Made/Missed)
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- Credit Utilization (Amounts Owed)
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- New Credit (Number of Hard Pulls)
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- Credit Age (Length of Credit History)
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- Credit Mix (Different Lines of Credit)
1. Payment History
Your payment history is the most important factor, accounting for 35% of your score.
This includes whether you have made your payments on time and if you have any late payments, delinquencies, or collections.
Make sure you never miss a payment, as this is such a big factor in calculating your credit score. Missing a payment even once could drop your credit by several points at once.
I would recommend you set up autopay as soon as you get your credit card so you never miss a payment.
Many people don’t know this, but you can also call the bank to change your credit card’s payment due date so they all line up if you have multiple credit cards. I like doing this since I have a set date every month to go through all my accounts to review my card’s history that past month and to make sure I didn’t get any incorrect charges.
2. Credit Utilization
Credit utilization is the amount of credit you use compared to your credit limit. This accounts for 30% of your score.
Ideally, you should aim to use no more than 30% of your credit limit. Though I would recommend you keep your credit utilization under 10%.
You can also pre-pay your credit cards to lower your credit utilization.
Ask Sebby has a great article on this.
3. New Credit
New credit, which is the number of new credit accounts you have opened, accounts for 10% of your score.
The credit bureaus track how many new credit lines you have by looking at your credit inquiries (hard credit pulls). Opening too many new accounts in a short period can be seen as a red flag.
When you’re applying for a new credit card, mortgage, or loan, the institution will contact the credit bureaus to check your official credit score.
Sometimes landlords also request to see your credit history when you are applying for a new apartment. If they were to check your credit score, this would also show up as a credit inquiry.
Hard credit inquiries fall off your credit report after 2 years. Because of this, I would recommend you apply for more credit lines early on when you first start building your credit.
This way, you will already have a good credit score when you need it for buying a house or getting a big loan. It is recommended to keep your credit inquiries under 4 to keep your credit score high.
4. Credit Age
Length of credit history, or your credit age, is the length of time you have had credit.
Your credit age accounts for 15% of your score. Having a long credit history can be beneficial, as lenders like to see that you have a track record of managing credit.
This is the reason I recommend everyone to apply for a credit card as soon as they can, ideally at age 18. Opening a credit card early on will allow you to start building credit faster.
I regret waiting until I was 21 years old to open my first credit card. I’ve been denied multiple times for some of the new credit cards that I wanted just because my credit history was too short.
5. Credit Mix
Types of credit, which is the mix of credit accounts you have, account for 10% of your score. Having a variety of credit accounts, such as a mortgage, car loan, and credit card can be beneficial.
The myth that having too many credit cards is false. It is only bad to have a lot of credit cards if you are unable to spend wisely.
These are the 5 elements of what you should know about your credit score.
Now that you have a good grasp on what you should know about your credit score. Here are the steps to improve your score.
Improving Your Score
To improve your credit score, there are several things you can do.
- Make sure to make all of your payments on time
- Keep your credit utilization low
- Try to maintain a mix of credit accounts.
- Be patient and wait, it takes time to build credit
- Set up an emergency fund and sinking funds
- Monitor your credit reports
Set up an emergency fund and sinking funds to avoid finding yourself in a situation where you are unable to pay off your credit card.
You can also check your credit report for errors and dispute them if you find any. Get 2 free credit reports per year here.
To Sum It Up
Your credit score represents your creditworthiness. It is calculated based on five factors and is used by lenders to determine your risk as a borrower.
By understanding how your credit score is calculated and what factors affect it, you can take steps to improve it and increase your chances of being approved for credit.
Having a good credit score as soon as possible can make a world of difference to your financial health further down the line.
Next, make sure you understand the 10 Credit Card Best Practices article before you get your first credit card, as it is extremely easy to get in trouble if you use credit incorrectly.