The Complete Guide to Credit Score for Dummies

Let’s say your credit score is 640. In other words, you’ve got fair credit.

Wait, what’s that?

If you aren’t familiar with credit scores, you’re probably wondering what this number is all about. What’s more, you aren’t alone. A 2019 survey estimated that one in eight Americans don’t know their credit scores.

Yet, your credit score is one of the most important numbers in the life of the average American adult. Without credit, getting a traditional, low-interest loan is hardly possible.

So, what else is there to know about credit scores?

Here’s the complete guide to credit score for dummies. Keep reading!

When Were Credit Scores Invented?

Credit scores aren’t as old as the lending industry.

Way back in the day, when the credit scoring system wasn’t in place, lenders relied on social connections to assess the risk involved in lending to a borrower.

You know, it’s more like how a friend of your friend can approach you for a loan. You don’t know what their money management habits are like, but you know that they are your friend’s friend, and your friend is a person you trust. Somehow, lending to that person makes sense.

Unfortunately, social approaches aren’t a reliable way to measure a person’s creditworthiness. In 1956, Bill Fair (engineer) and Earl Isaac (mathematician) teamed up to create an impartial FICO credit scoring system. However, it wasn’t until 1995 that the FICO model went into use, quickly becoming the industry standard.

The FICO credit score is a number between 300 and 850. The system considers a range of factors, synthesizes the information, and awards every credit-active consumer a score.

Anything from 300 to 579 is poor credit. 580 to 669 is fair credit, 670-739 is good credit. Very good credit starts from 740 to 799, and 800 to 850 is exceptional credit.

The FICO scoring system isn’t the only one in use. There’s also the VantageScore, but the score range is still from 300 to 850.

What Affects Your Credit Score?

So, in a nutshell, some invisible system gathers your information and unilaterally decides to award you any number between 300 and 850. How fair can it be?

Well, you have no reason the doubt the fairness of the credit scoring models. They are robustly designed and thoroughly tested to ensure a high level of accuracy.

But what specific information do they use? In other words, what affects your credit score?

Here’s are some of the most important factors:

Payment History

Payment history influences 35 percent of your credit score.

When you take out a loan, be it a student loan or personal loan, you have to repay it. Every payment you make goes into your payment history.

If you’re always making payments on time till you clear the loan, your credit score will likely be on the higher side. But if you’re ever late or sometimes don’t pay at all, you’ll be doing a good job at ruining your credit score.

Utility bills don’t typically form part of your payment history, but they can negatively affect your credit if you default on a bill and the service provider reports you to credit bureaus.

Debt to Credit Score Ratio

Debt to credit ratio is a measure of how you use credit relative to your limit.

Let’s say you have two credit cards, each with a $1,000 limit. So, your combined credit limit is $2K. This month, you spend $1K. This means your debt to credit ratio is 50 percent.

The credit scoring models will award you with a better score if you maintain a low debt to credit ratio (below 10 percent), but anything below 30 percent is still good.

Therefore, don’t rush to wipe your credit cards clean every month, at least not when you want to build and maintain good credit.

Credit Report Inquiries

Every time you apply for a loan or credit card, the lender will perform an inquiry on your credit history. These inquiries are necessary, but too many of them will affect your score.

You see, it’s never a good sign when you’re applying for loans left, right, and center. Anyone can easily conclude that you’re in financial pressure.

There are other factors that will affect your credit, but these are the most important.

What Are the Consequences of Having Bad Credit?

A poor or negative credit score doesn’t just make it hard for you to secure traditional loans at favorable interest rates. It can make your life harder in other areas too.

For example, landlords routinely do credit checks on prospective tenants. This way, they can tell whether a rental applicant has a questionable payment history. With bad or poor credit, your chances of securing a rental house are slim.

Some non-financial service providers, such as telephone companies, also do credit checks before approving a customer for a cellphone plan.

That’s not all. If your credit score is bad, you can miss out on certain jobs, especially those in finance. Can you imagine any employer trusting you with the company’s finances when you can’t be trusted with your own finances?

What Should You Do When You Have No Credit?

Having no credit isn’t the same as having bad or poor credit. No credit means you don’t have a credit score, likely because you have never taken out any loans or credit cards.

If you want to become credit-active and start building your credit score, it’s simple. Just apply for a secured credit card or a credit builder loan. Once you start making repayments, credit scoring systems will capture your information.

Make Use of This Guide to Credit Score for Dummies

Your credit is more than just a number. It’s a numerical summation of your financial history so far. If you didn’t know how credit scoring works or how bad credit affects you, this guide to credit score for dummies has no doubt come in handy.

Stay hooked to our blog for more credit tips and insights.

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