How to Understand Your Credit Score and Why is it Important?

You’ve heard the numbers: 690, 740, 805. Three simple digits that may seem mysterious, abstract, or both. However, in the real world, your credit score largely determines what type and how much credit you can get, what interest rates you’ll pay, and sometimes whether you’ll get that great new job you want.

Do we have your attention now? I thought so. Understanding how the big three credit bureaus (Experian, Equifax, and TransUnion) calculate your credit score is key to learning how to proactively manage your credit and safeguard your triple-digit credit score.

Credit Score
Credit Score

Your score allows companies to assess your ability to repay the money you borrow. Checking your credit score and taking steps to improve it if necessary are key steps in buying a new home.

As the saying goes, without pain there is no gain. Investing time now to understand your credit report and credit score will pay you big dividends throughout your life.

Here’s what you need to know:

  • The big three credit bureaus focus primarily on what you owe and your payment history.
  • The most commonly used credit score, also known as the FICO score, ranges from 300 to 850.
  • Standards can change, and in some cases, have increased for mortgage lenders, in terms of what is considered a good credit score.
  • There is consensus among experts that 720 is a good score. 740 or more will usually give you the lowest interest rates and the best terms.
  • Your score helps companies predict the odds that you will be 90 days in default (or default) over the next two years with the money they lend you.

Your FICO Score is based on 5 factors, weighted as follows

  • Your payment history: 35% of your score.
  • Amount of debt you owe: 30% of your score.
  • Duration of your credit history (usually, the longer, the better) 15% of your score.
  • Amount of new credit you apply for (too many credit applications, especially in a relatively short period of time is negative): 10% of your score.
  • Types of credit you use: 10% of your score.

Mortgage, auto loan, and credit card lenders use your score to help understand your ability to pay off debt, based on your previous payment history. Some newer credit models take into account your income and work history. However, the old saying remains true: the best predictor of future behavior (in this case, paying bills on time) is past behavior.

You may be thinking, it seems that credit scoring is all about rating me or even judging me. While there’s some truth to that, credit scores benefit us all as consumers, in important ways:

How to check your credit?

  • Consumers are entitled to a free credit report every 12 months.
  • All three credit bureaus have a website, http://AnnualCreditReport.com, for that purpose. Use that site. Be careful of others.
  • Your credit report will contain detailed information. You need to look for errors and correct them.
  • Your actual credit score may cost a nominal fee, such as $10, but it’s a worthwhile investment.

Steps you can take to improve your credit score over time:

  • Pay your bills on time.
  • Reduce your debt.
  • Find and correct any errors on your credit report.
  • If you have bad debt, pay it off and request that the debt be marked as paid on your credit report.
  • Be patient. None of these steps are instantaneous. However, experts agree that they will work over time.

Now that you understand your credit score, you might want to talk about your SAT score, cholesterol level, or weight. Ah, that’s what I thought! However, with your new credit scoring knowledge and the steps above, the odds that you’ll be able to get the new house, car, or job you want are good, without a credit score getting in your way.