Ever wondered what your creditor looks for in your profile when you apply for a loan, credit card, or other credit product? Good question. Asides from your employment history and gross monthly income, one of the main components they’ll be examining is your credit score. You might not realize it yet, but there are actually several different versions of your credit score. Lenders will generally use one of these versions when considering you for new credit.
However, just what are these credit scores and how do they affect your financial situation? How can a high credit score help you and a low one cause you problems? If you’d like to know more, just keep reading, because the Rebound Finance team has some tips that you might find useful.
Want to know what really happens when you ruin your credit? Find out here.
Credit vs. Interest
Before we delve further into the idea of credit scores, it helps to get a basic understanding of what credit and interest are, and how these elements relate to your own credit scores.
“Credit” refers to money that you can borrow from various sources, such as banks, credit unions, and other organizations are commonly known as “lenders” or “creditors”. When some people hear the word “credit”, they often think of credit cards. While credit cards are the most widely used form of credit, they certainly aren’t the only kind. There are personal loans to cover basic expenses, auto loans to make cars more affordable, and mortgages for buying houses. Not everyone can afford these kinds of costs immediately. So, if needed, we can borrow the funds from our creditors, who will give us a specific payment schedule so we can pay them back in the weeks that follow, rather than all at once.
Wondering if you should pay off your mortgage early? Check this out.
Before you apply for a credit product of any kind, it’s very important to consider what that product might end up costing you down the road, both in terms of loan money you’re spending and how expensive the service itself will be. Remember, all lenders are running businesses, whether they’re banks or otherwise. They need to charge a certain fee for the use of their products, known as an “interest” rate. This is one of the main reasons why it’s beneficial to maintain a healthy credit score. Lenders often examine your score before they let you borrow. Since a high credit score is a signal that you’re more creditworthy (meaning you’re more likely to pay your debts responsibly), they’ll also offer you a lower, more affordable interest rate for the use of their products.
Remember, when a lender is considering you for a credit product, they won’t just be checking your credit score. They’ll want to be certain that you have a high probability of paying them back in full and on schedule. So, they’ll also be checking things like your employment record, your social security number, and your “credit report”. Your credit score is a bare-bones representation of your credit health as it stands currently. On the other hand, your credit report is a far more detailed file containing your entire history of credit usage over the last 7-10 years. So, if you have a good credit score now, but your creditor sees that you’ve had a lot of debt issues in the years prior, that might make them more skeptical about taking you on as a potential borrower.
In the U.S., there are 3 main credit reporting agencies or “credit bureaus”; TransUnion, Equifax, and Experian. Each of these agencies has slightly varying versions of your credit report and credit score on file. As working with any of these bureaus costs money, creditors draw their borrowers’ credit information from only one. When you apply for new credit, your creditor will perform a hard “credit inquiry”, which means that they’ll request a copy of your credit report and credit score, and their bureau will provide it for a fee. If your creditor sees a high score and a positive record of credit usage in your report, they’ll be more likely to approve you and give you a lower interest rate. In turn, your creditors will relay your own payment records back to the bureau, who will update your report and score accordingly.
Credit Score Ranges in the U.S.
While there are several versions of your credit score, one thing is certain. The higher your credit score is, the better your chances will be of receiving approval for credit products and more affordable interest rates to go with them. Generally speaking, however, your average credit score is a 3-digit number ranging somewhere between 350-850 but will vary according to your lender and the credit bureau they’re working with. Each bureau also provides you with a basic consumer credit score, which you can request online, by mail or phone for a small fee.
Whether or not you’ll be approved with your own credit score is dependant on which lender you’re applying with and the value of the credit product you’re trying to get. Unless your score is terrible, you shouldn’t have much of a problem getting approved for a regular credit card. However, if you’re trying to borrow money from a prime lender (banks, credit unions, etc.) for a downpayment or a mortgage, both of which can cost tens, even hundreds of thousands of dollars, your score will need to be within the “fair” range (650-699) or above. Some prime and subprime lenders will still approve you with a score lower than fair if you have a good income. Unfortunately, you could end up paying a very high-interest rate, costing you thousands more than if you had a good score.
To see how your credit score is calculated, check out this infographic.
U.S. Credit Score Providers
As we mentioned, each credit reporting agency has a particular way of determining your credit score. Actually, at any given time, there are at least 3 different versions of your score that creditors can use to judge your creditworthiness, all of which are calculated through a different credit score provider. Generally, credit bureaus get several versions of your score from two independent providers, then follow it up using a calculation system of their own design.
FICO Credit Scores
The most commonly used credit score provider is FICO (Fair Isaac Corporation), which was established in 1960. All three credit reporting agencies work with FICO to come up with your basic credit score. If a borrower has a FICO score, it means that they have at least one credit account that’s been active for 6 months or more, and at least one account that’s been reported to all three bureaus within the past 6 months (which can be the same account).
Each credit bureau also has numerous variants of your FICO score available, which range in accordance with the type of account you have active. There’s your basic FICO score, followed by your “FICO 8”, “FICO 9”, “FICO NextGen”, “FICO Auto” and “FICO Bankcard”, all of which are used by the three bureaus and correspond to various forms of credit products.
Still trying to understand your FICO credit score? Read this for more information.
More recently, the credit bureaus have also started using another credit scoring system, known as “VantageScore”. This system was actually created in 2006 by the agencies themselves as a way to calculate credit scores without paying for FICO’s services.
While this system works more or less the same way as FICO’s, it uses different borrower criteria, giving a slightly different score for each client. For instance, while FICO does not take your utility fees, rent or phone bills into account, VantageScore does. VantageScore also provides several versions of your credit score that your creditors can choose from, including Vantage 2.0 (which ranges from 501-990) and 3.0 (which ranges 300-850).
TransUnion, Equifax, and Experian Credit Score Ranges
While all three bureaus use the FICO and VantageScore credit scoring systems, they will also provide a more basic, in-house version of your score at your creditor’s or your own request.
TransUnion offers their “New Account Score 2.0”, ranging from 300-850, which was created to help banks and other financial institutions oversee their borrowers’ active accounts. Your creditors might use this score as a way to determine the probability that you’ll default (won’t honor your loan agreement) within 90 days of your approval.
Equifax mainly uses their VantageScore and FICO credit scoring systems, which also range from 300-850.
Experian generates a few in-house versions of credit scores, including the “PLUS Score”, which ranges from 330-830 and is only available to consumers, not creditors. They also offer a “National Equivalency Score”, which ranges from 360-840, as a way to refine the portfolio analysis process for some creditors, as well as credit scores/reports for businesses, and background investigations for landlords.
Breaking Down Your Credit Score
While FICO, VantageScore and all three credit bureaus do provide several formats, your basic credit score can be divided into 5 subcategories. Each subcategory affects the way your score fluctuates.
Payment History – 35%
This refers to how you’ve been handling your credit account payments (credit card bills, lines of credit, car loan/mortgage payments, etc.). If you’ve been making all your regular payments on time and in full, your score will gradually rise. However, if you’ve been making short payments, late payments, or even worse, missing them altogether, your score will drop. The same effect will occur following any financial delinquencies you go through, such as consumer proposals, accounts in collections and bankruptcies.
Read this to know why debt consolidation might affect also your credit score.
Credit Utilization – 30%
This category alludes to the amount of credit you’re using currently. Every borrower has a credit utilization ratio, which can be calculated by tallying up the balances of your debts and weighing that total against the amount of credit you have available. Keep your utilization ratio below 35% for the best results.
Age of Your Credit Accounts – 15%
The age of your credit accounts is also very important. The longer you’ve had an active account with a good record of payments, the better it will be for your credit score.
Wondering if gambling decreases your credit score? Click here for the answer.
Account Variety – 10%
It’s also beneficial to your credit score when you have a variety of credit products (credit cards, loans, etc.) listed in your credit report, even better when you’ve been managing them all properly over a number of years.
Credit Inquiries – 10%
Whenever your lender performs a credit check, a “hard inquiry” will be listed in your credit report, where it will remain for approximately 2 years (times vary according to the credit bureau they hire). That inquiry will cause your score to decrease by a few points, the effect of which will last for 12 months. It’s important not to apply for too much new credit during that 12 month period because doing so will not only decrease your score further but could make future lenders think you are a borrowing risk.
To learn more about how credit inquiries and your credit score are related, read this.
Raising Your Credit Score
The path to a good credit score is not always easy, but if you put forth the effort, it will definitely be worth it in the long run. As we mentioned, not only can a high credit score improve your chances of getting approved for various credit products, it can potentially save you a lot of money in interest fees. Because of that, it’s best to raise your score as much as possible before you start applying. You can do so with these simple methods:
Obtain a Yearly Copy of Your Credit Report
The first step you should take when trying to fix your credit is to request a copy of your credit report (by mail, phone or online) from TransUnion, Equifax and Experian. You are entitled to one free copy of your report from any credit agency every 12 months (you can request more copies for an extra charge). You can also obtain your credit score for a flat fee. Doing this will help you understand the health of your credit and how it works.
Dispute Any Errors You Find
Remember, every credit bureau has a different version of your credit profile and each of your creditors only work with one of them. With all the information being reported to each bureau on a daily basis, it’s possible that errors caused by misspelled or incorrect information, identity theft or fraud have been made on one or more of your profiles. That’s why it’s beneficial to request your report and score from all three bureaus, rather than just one. These errors can damage your credit score severely if they go uncorrected. If you examine your report and find any errors, you can fill out a dispute form and send it to the agency in question. If the error is justified, the agency will correct it and your credit score will increase gradually.
Pay Down Your Other Debts
We can’t stress this enough. Always take care of your other debts before applying for more credit. Not only will this make you a less risky borrower, it’s a good way of confirming that you’ll be able to afford your future products. If you pay your debts, but don’t have enough money left to cover the cost of your potential loan payments, consider waiting until you can increase your savings again.
Pay Your Bills On Time
It’s also extremely important to pay your debts on time. Every late and/or missed payment earns you a penalty fee and decreases your credit score by a few points. If you have the appropriate funds but you just have trouble remembering to pay your bills by their due date, you can set up automatic payments through your bank.
Pay Your Bills In Full (Whenever Possible)
It’s also essential to always pay your full balances whenever you can. While sticking to the minimum payments on your revolving credit products (credit cards, lines of credit, etc.) might protect you from late penalties temporarily, you’ll rack up interest with every dollar that goes unpaid. This adds to your debt, which can eventually lead to missed payments, followed by a drop in credit score.
Don’t Apply For Too Much New Credit All At Once
As we mentioned above, every time a creditor pulls a copy of your credit report, it’s known as a hard inquiry, which decreases your credit score by a few points over a period of 12 months. If one or two lenders deny your applications, it’s best not to continue applying all over town. Other lenders will eventually see that you’re being denied constantly and consider you a borrowing risk. If this happens, wait a few months until you can increase your credit score again.
Request a Credit Limit Increase (If Possible)
Using more than 50% of your available credit can cause a decrease in credit score. When possible, it’s recommended that you use no more than 35% of your available credit. If you can’t manage this, contact your credit card company or other lender and request a credit limit increase. If you’ve been a good client so far, you may already be pre-approved for one.
Apply For a “Secured” Credit Card
These kinds of cards are normally marketed toward borrowers who already have bad credit and don’t qualify for regular credit cards. If you’re in a similar situation, a secured card can help you raise your score until you do qualify for a regular one (if you use it responsibly, of course). They’re called “secured” because you need to add a security deposit in order to be approved, which will be equal to the credit limit you want. That deposit is meant to be used as collateral. If you default, you risk losing your deposit. Otherwise, it functions like a normal credit card. When your secured card is about to expire, pay your full balance and your deposit will be returned. If you’ve managed to raise your credit score by that point, you can then apply for a normal credit card.
Choosing Rebound Finance
Building and improving your credit score can be a long and tiresome process but it will definitely benefit your finances if you put in the effort. If you’re looking for the right product to help you boost your credit score, Rebound Finance should be your first choice. We’ll get you connected with the best sources for all your credit building needs!