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Financial Literacy: Credit Scores



What is a credit score?


A credit score is a three digit score of how likely someone is to pay back a loan. A credit score usually ranges between 300 and 850. Credit scores might affect the terms of a loan or credit account someone applies for. Additionally, a person can have many credit scores and there are numerous credit score models. Credit scores are provided by the consumer reporting agency, which are organizations that create credit reports. Credit reports illustrate a person’s payment behavior and places they have worked.




What credit scores make a positive impression?


Although there is no set number that will provide a person with a new credit account or a specific interest rate, the higher the score the better. If a person’s credit score is from a range of 670-739, that will be a range that can demonstrate responsible credit behavior from the past. This will help when potential lenders and creditors consider a new request for credit.


What is considered when calculating credit scores?


There are five factors when calculating credit scores. This includes someone’s payment history, how much they owe, the length of their credit history, the types of accounts they have, and recent credit activity.


  • Payment history: This counts as 35% of someone’s credit score. This will illustrate whether someone makes payments on time, how often they miss payments, how many days past the due date they pay their bills, and how recently they have missed payments.

  • Amount owed: This will be 30% of someone’s credit score. This will take into account the entire amount someone owes, the number and types of accounts they have, and the amount of money owed compared to how much credit someone has available.

  • Length of credit history: 15% of your credit score will be the length of someone’s credit history. It is more beneficial to have a longer history of making payments on time and will look more appealing to creditors and lenders.

  • Types of accounts someone has: This will be a small fraction of 10% of someone’s credit score. When someone contains a variety of accounts including installment loans, home loans, along with retail and credit cards, this helps to improve their credit score.

  • Recent credit activity: This will also be 10% of someone’s credit score. It could raise red flags if someone has opened a lot of their accounts or applied to open accounts, since that could indicate financial issues and may lower someone’s credit score.

How to improve your credit score?


There are multiple methods of improving credit score. By paying bills on time, increasing credit lines, not closing credit card accounts, working with credit repair companies, and correcting any errors on credit reports.


  • Paying bills on time: Having six months of payments paid on time will give a positive difference to a person’s score.

  • Increasing credit lines: With credit card accounts, it is beneficial to call and ask about a credit increase. This will provide more buying power and help someone’s credit score by lowering credit utilization ratio. A credit utilization ratio is the amount of revolving credit used divided by the total credit available.

  • Do not close a credit card account: Closing a credit card account could possibly change someone’s debt to credit utilization ratio, which may affect credit scores. Moreover, this could determine how well someone is managing current debt. It is best to stop using a credit card then to close the account.

  • Working with credit repair companies: Credit repair companies can negotiate with creditors and credit agencies for someone’s behalf in exchange for a monthly fee.

  • Correct errors on credit report: People are allowed one free credit report annually from each of the main credit bureaus in order to keep information secure.

Why are credit scores vital?


If a person has a higher credit score, this could possibly allow them to have better credit terms such as lower payments and less interest being paid.




References:


Investopedia


Equifax


Wells Fargo

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