We have all been drilled endlessly about the importance of a good credit score. Your credit score can determine everything from the type of car you can buy to which types of homes you will have a loan approved for. Some employers even go so far as to run a credit report before extending an offer to a potential hire.
So with something as ubiquitous and important as a credit score, it’s helpful to know what goes into creating your score, and how exactly it affects your life.
Credit Scores are a Recent Invention
A long time ago, lenders determined how they gave loans to people using long and arduous processes. Often they would have to call your references, find businesses you frequented to see how well you paid the bills, and sometimes even drop by your house to have a look around.
This was as recent as the 1950’s.
In this larger, global, digitized economy, it’s impossible to determine creditworthiness in this way. Most people do not have a personal relationship with their banker. Millennials rarely set foot in a bank, and with the growth of online banking, most of Gen Z will follow those footsteps…or lack thereof. Credit scores, invented by William Fair and Earl Isaac, are a way of determining how risky of an investment a loan was to a consumer- without personally knowing the consumer. Based on data and algorithms that are constantly being refined and recalculated, a credit score allows a lender to identify if they can give someone a loan without having to know the person.
There Is More Than One Credit Score.
When we think of our “Credit Score,” the number that often comes to mind is the one generated by FICO. The FICO score is the most recognized and widely known score…but there are 49 different FICO scores. Additionally, the three large credit bureaus (Experian, TransUnion, and Equifax) all each have their own consumer credit score. And if that isn’t enough, there are literally hundreds of credit scores, each for different types of loans, or specific to a certain organization. There are certain credit scores that determine things from getting a credit card or a student loan, and different credit scores to determine your ability to get a mortgage or car loan.
Regardless of which score is used, they all aim to do the same thing. They rate each consumer based on a scale that is a measure of how much of a risk they are to lenders. In other words, the score gives an estimate of how likely you are to pay back the money that is given to you by a lender. And the higher your score is, the more “creditworthy” you are deemed by a lender.
What are they looking for?
So what makes a person more “creditworthy” when it is time to decide on lending? Several factors play a role in your ability to get a loan but the most important ones are:
How often you pay your bills on time every month. From your cell phone and utilities to mortgages and car payments, making sure you don’t miss your deadlines is a critical part of keeping a healthy credit score.
Length of credit
How long you have had an open account is also a big factor. If you’ve managed to keep an account for several years without going into delinquency it shows that you’re less likely to be a risky borrower.
Types of credit
Diversity is key. Having a few different types of credit helps to show the lender that you are able to handle more than one thing at a time, and increases your credit score.
The general rule is not to use more than 30% of your credit. This isn’t just because it’s a bad idea to overspend, but because it shows that you’re able to earn enough to not have to rely on credit.
Thinking about applying for a few credit cards before you go out and purchase a car? Think again. When you apply for a student loan, car loan, or credit card, lenders will do a ‘hard pull’ on your credit. This means that the act of them finding out your credit information causes your credit to take a hit. Too many of these inquiries and you could find yourself just shy of qualifying for things you otherwise would have.
Why So Many?
There is no “one size fits all” when it comes to people, and this applies to the type of score you have as well. The same person can have slightly different scores with different agencies. This variation is caused by the fact that not all things carry the same weight when a creditor is deciding on how to lend to a consumer. Creditors weigh things differently when deciding to give someone a student loan versus a mortgage, causing your score to be slightly different from one company to the next.
Despite the variations in each of the different scores, knowing your credit score is incredibly useful and will give you a great ballpark of where you stand. By law, you are entitled to one free credit score from each of the major agencies every year.
So, if you’re ready to make a big purchase in the future, knowing your credit score will be the first step towards achieving that goal. Take the few months ahead of time to focus on getting your credit to where you want it to be. Although it will some work, the pay off will be worth it- especially if you plan on buying a home. And when you’re ready Morty can help you find the best lender to suit your needs, so you can start working towards your dream.