What Is A Credit Score And Why Does It Matter?

What Is A Credit Score And Why Does It Matter?

You probably won’t be shocked to read that your credit score is incredibly important, but why is that, exactly? Simply put, this magical little number is used to define your financial status in the eyes of many people and institutions you need to deal with. That being said, many people don’t really know what is a credit score, meaning they don’t have a real understanding of what goes in it and how it’s affected depending on your life choices. If you’re among the people that could use a bit more information on this subject, don’t worry, we’ve got you covered.

What’s a Credit Score?

Let’s start with the basics: a credit score is a three-digit number that financial institutions (mostly credit card companies and banks) use to assess your creditworthiness and your risk-profile as a credit user. In short, these institutions rely on this little number to evaluate the likelihood that you’ll pay back the money they intend to lend to you. If you have a good credit score, you’ll never have any problem getting insurance, opening lines of credit or being approved for personal loans. If your magic number is a bit too low, on the other hand… Well, that kind of thing won’t go as smoothly as it could, as we’ll discuss below.

How is it Calculated and Used?

Good question because knowing that information comes really handy when you’ve got tough choices to make (which check to send when there is too much month at the end of your money, for example…) The credit score calculation is based on a thorough analysis of the data contained in your credit report. Your credit bureau, TransUnion or Equifax, is the entity that will proceed with the calculation. Although financial institutions are the primary users of this information that helps them make big decisions about the products and services they offer you (insurance premiums and interest rates come to mind), an increasing number of third parties are now requesting to have access to this piece of data (landlords, employers, phone companies, etc.) to draw wide-ranging conclusions about you as an individual. Fair? Maybe not, but it’s still happening, so… 

What are the Main Factors that can Hurt My Score?

One of the main factors that influence your credit score is debt. The amount of debt you carry, the type of debt it is, how long you’ve carried the balance on each debt and how long it would take you to pay the money back are central questions when it comes to credit score calculations, and it’s easy to understand why. Considering the purpose of a credit score, your payment history and the amount you already owe weigh in on 2 thirds of your overall score. Overall, your credit score is affected by credit utilization (which proportion of your available credit you’re actually using), your payment history (the more stable the better), your credit history (the longer, the better), your credit mix (the number of different types of credit products you use), and also the number of credit inquiries you’ve made in the recent past.

What’s a Good Credit Score?

Credit scores usually fluctuate between 300 and 900 points, depending on the exact model used. We’re talking about a good score when it’s anywhere around 700 or above. The higher your score is, the easier it will be for you when dealing with financial institutions and any party with a vested interest in your solvency. That being said, if you have a good score now, don’t rest on your laurels just yet. While building a top-tier credit score can take years of timely payments and responsible behavior with creditors, we’re all just a few late payments or forgotten bills away from dropping into low-grade territory when it comes to creditworthiness!

What can I do to Improve My Credit Score?

Improving one’s credit score is both not complicated and hard since it’s relatively straightforward but requires a certain amount of discipline that people with low credit scores typically lack. A lot of online so-called experts offer all kind of credit clean-up services or easy fixes, but there really are only 2 big things you can do to get and maintain a good credit score:

  • Paying your bills on time: you probably won’t be shocked to learn that paying your bills and making your card / debt payments is the single most important thing you can do to keep a healthy credit score. If you have trouble staying on top of your bills and other recurring monthly commitments, you can set up pre-authorized payments on most of your major financial obligations such as student loans, mortgages, credit cards, and auto loans. That alone accounts for more than a third of your credit score!
  • Don’t load up your credit cards: and this advice is good for all your credit instruments that come with a predetermined ceiling. One of the worst things you can do to your credit score is to max out your credit lines and cards on a regular basis (even if you pay them in full when you should!) or to keep high balances on all of them pretty much all the time, no matter if you make the minimum payment on time. Good practices recommend to keep your credit utilization at about a third of your available limits.

Hopefully you now know what’s your credit score and how it affects your life, how it’s calculated, and what you can do to improve it. You have all the tools to make better financial decisions for your future!

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