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July 29, 2020

Credit Scores: What Are They And Why Do You Need One?

Uncover the mystery behind credit scores and why you need them.

Credit scores may be more important than you think. A good score could help you get lower interest rates and open up opportunities to buy the house of your dreams. Investing time in managing your credit score could mean saving thousands of dollars in interest down the road. Learn the basics of what a credit score is and how it can affect your financial life.

What is a credit score?

For many, a credit score is a term they hear about a lot but only worry about when it’s time to make a big purchase. Credit scores can seem mysterious, but they are much simpler than you think. Credit scores are three-digit numbers that can range from 300-850 that depict your creditworthiness. Basically, a higher number makes you a more attractive borrower to a lender, while a lower number could make lending to you seem riskier. Scores are calculated using different categories from your credit history.

If your credit score seems lower than it should be, be sure to request a credit report to ensure there are no errors or fraudulent accounts included. Fix any errors on your report to make sure your score accurately reflects your situation and history.

Why do you need one?

If you plan on owning your own home, buying a car or other large purchases without cash, you will need a credit score. Lenders look at your credit score to determine the risk of loaning you money. The higher your credit score the more attractive you will look to a lender and, most likely, the lower your interest rate will be. These scores aren’t the only thing lenders consider, but a better score will give you more options.

Scoring models

There are several different scoring models, but the top two are FICO and Vantage scores. The FICO model was created by the Fair Isaac Corporation and is the most commonly used by banking institutions. Each factor used in their formula is weighed differently. The Vantage score, created in 2006 by the top three credit bureaus–Experian, Equifax and TransUnion, uses the same number range as the FICO model but category weight percentages vary. The exact formula changes between companies, but the most common factors are:

  • Payment history
  • Length of credit
  • Types of credit (credit cards, auto loans, student loans, mortgages, etc.)
  • Credit limits and the percentage of each in use
  • Amount of debt
  • Hard inquiries into your score

How can you improve your score?

A good credit score is generally anything above 670, but the higher the score the better. As a general rule of thumb, good money management will help maintain a higher score in the long run. If you’re looking for some proven ways to increase your score, try these:

  • Pay your bills on time
  • Increase your credit limits
  • Keep credit cards open
  • Vary the types of credit

If you aren’t doing any items on this list, try them out and your score should increase with time. Be sure to use the same scoring model every time you check your credit score as different scoring models can yield different results. Scales fluctuate between companies, so keep as much consistency as you can. As you work to improve your score, set idealistic expectations. Improving your credit score takes time and small fluctuations are normal.