featured image via Müjgan Afra Özceylan
Editor’s Note: Today’s post is authored by Erica Holland. In addition to her full-time role at a private equity firm, Erica runs a personal finance and lifestyle blog, ModMoney, where she simplifies personal finance in a relatable way, and dives into important “real world” topics seldom taught in school.
Most of us have swiped a credit card, paid a mortgage, or applied for a personal loan. Which also means we have a credit score that reflects how well we’ve managed it all. Monitoring your credit score may not be the most glamorous task, but it’s an important one because a lot is at stake. Your credit score can impact loan approvals, interest rates, insurance premiums, and even your next job! Here are some key things you need to know.
1. Your credit score comes from your credit report.
Every time you borrow or repay money, your activity is reported to the three big credit bureaus: Experian, Equifax, and TransUnion. Each bureau puts together a report that documents your credit history, and that’s where your score comes from. You can pull these reports for free once a year by going to AnnualCreditReport.com. It’s important to check these so you can catch any errors and detect fraud.
2. You have more than one credit score.
There are a variety of credit scores out there, but FICO is the most commonly used among lenders. However, even your FICO score can differ depending on when it was pulled and which of the three credit bureaus it came from. In any case, most scores are based on the same formula with a scale of 300-850, so they should only vary slightly. Anything over 670 is considered good, over 740 is very good, and over 800 is exceptional.
3. There are five factors that determine your credit score.
Knowing how your score is calculated can help you isolate what you need to work on to improve it. In order of importance, your score is based on:
- 35% – Payment history: This one is pretty simple. It reflects your track record of making on-time payments.
- 30% – Utilization: This is the amount you owe as a percentage of your total credit limit. The ideal ratio is around 20%.
- 15% – Length of credit history: A longer history is better because it gives lenders more insight into your behavior. If you just started developing a credit history, it may be hard to get a score in the 800s right away.
- 10% – New credit inquiries: Each time you apply for a new card or loan, the issuer makes an inquiry into your credit history, which dings your score by a few points.
- 10% – Types of credit: Lenders like to see that you can manage a mix of retail accounts, credit cards, mortgages, and other personal loans. If you don’t have a broad mix of credit, no biggie. It’s the least important factor.
I spoke about these factors and how you can improve them in The Ultimate Guide to Understanding Your Credit Score. And if you ever wondered how you can responsibly use a credit card to build up your credit score, check out 5 Credit Card Rules You Should Definitely Be Following.
4. Your score can impact your life in a variety of ways.
Have you ever had a friend who borrowed some cash and never returned it? Chances are, you’re hesitant to lend her any additional lunch money. Similarly, prospective lenders use your credit score to evaluate your risk as a borrower. This manifests itself in several ways. First, your score dictates whether you are approved for a credit card, a mortgage, an apartment lease, a car loan, or any other personal loan. A low score can also cost you serious cash because it determines your interest rates. If lenders perceive you as a risky borrower, they charge you a higher rate to protect themselves. Plus, a low credit score also means higher insurance premiums and security deposits on your utility bills. Finally, your credit score can show up on employee background checks. Nobody wants to be rejected from their dream job because of a poor credit history!
5. You can monitor your score for free.
Several credit card issuers offer their cardholders a free FICO score. Additionally, technology applications have made it easy to monitor and improve your credit score. Credit Karma is one such app that provides access to your credit score and credit reports for free. Credit Karma also makes it easier to raise your score because it tells you exactly where you stand on each of the five factors. Now that your score is free and accessible, there’s no excuse not to monitor it.