Explaining Credit Scores: You Can Get On Top Of Your Credit!
While credit scores are not the end-all, be-all measurement of financial responsibility, having a good credit rating can mean the difference between becoming a homeowner versus being a lifelong renter.
Though renting is also a viable way to make sure you have a roof over your head while establishing your financial security, most apartments, condominiums, and landlords require a credit report at the time of your rental application submission. Beyond the narrow, yet important scope of establishing a household, there are additional considerations for maintaining a good credit score.
What is Your Credit Score Used For?
Credit score can do a lot for you in financial elements of your life. In certain U.S. states and cities, credit scores are used in hiring decisions. For example, in Las Vegas, it’s not uncommon for a background check to include pulling up your credit report. Though many might find this to be intrusive, if you’re handling money, casinos and other local businesses might use the credit report as one part of their risk metric.
Now, this doesn’t mean they have access to your credit score, nor can they see specifics regarding account numbers, etc. And certain states either prohibit or severely limit (Nevada does have limitations) employers from using your credit history as a part of their hiring decision. But it doesn’t hurt to keep all of your loan and credit card payments timely.
If you’re in the market to make a large purchase like buying a new vehicle, but don’t have the cash to buy the car outright, the dealership (specifically their loan officer) is going to require access to your credit score and report. In case you’re wondering, the credit score is a three-digit number ranging from 300 to 850. Your credit report lists your payment history, accounts, inquiries, and public records, including bankruptcies, foreclosures and so forth.
What is a Good Credit Score?
There are different versions of the FICO scores, and not all industries use FICO. Some use VantageScore instead. However, in general, the numerical scales of both follow a similar pattern:
- 720 or higher: Excellent
- 660 to 719: Average
- 620 to 659: Poor
- 620 or lower: Bad
The difference between FICO and VantageScores is how they are calculated, meaning the weighting of factors they use to calculate that final three-digit number. To illustrate, FICO scores apply the following percentages to each category:
- 35% Payment history
- 30% Amounts owed
- 15% Length of credit history
- 10% Types of credit cards used
- 10% New credit
Meanwhile, VantageScore grades the categories slightly differently:
- 32% Payment history
- 23% Credit utilization
- 15% Balances
- 13% Depth of credit
- 10% Recent credit
- 7% Available credit
Because of this, your VantageScore and your FICO score are not likely to be the exact same number. Add to this that FICO offers different credit scoring depending on the industry (e.g. automotive, credit cards, and mortgages), and each of these differences may also produce a slightly different credit score. Further credit scoring variations arise depending on the score calculated by the three major credit reporting bureaus: Experian, Equifax, and TransUnion.
How to Establish or Improve Your Credit Score
For most consumers, establishing a credit score comes about with obtaining a credit card. The post-2007–2008 fiscal disaster gave rise to lending institutions increasing their offerings of credit cards for those with sub-prime credit or those who are just beginning their “debt journey.” There is such a thing as having too many credit cards, though the credit reporting agencies and FICO don’t specifically state what counts as “too many.”
Considering the largest chunk of your credit score calculation comes from your payment history, it’s safe to say that making on-time payments is the number one way to initialize a good credit score or improve a less-than-stellar one.
Credit utilization is also a key metric to building long-term wealth. If you have three credit cards and each is maxed out, while you’re only making minimum payments, this can also weaken your score. Therefore, it’s wise to limit your credit card debt and make sure those cards are paid off as quickly as possible to avoid developing bad credit.
Once you have demonstrated budgeting skills, with on-time payments for 6 to 12 months, and you’re not carrying large balances on your credit cards, then you may be in a prime position for an auto loan or other financial investment options that are available. Mortgages are a trickier situation, as lending constraints depend on the financial institution’s internal requirements. Your partner's credit score can also factor into buying a home, so it's important to have your shared finances sorted out beforehand.
Suffice to state that if you continue to make timely payments on the cards or loans that you do have, and your utilization ratio (outstanding balances of all credit cards divided by the total of each card’s limit) is low, you’re well on your way to tackling more advanced budgeting skills and reaching an excellent credit score.