Understanding your Credit Score

Credit is the lifeblood of our economy. Most people need to borrow money at some point in their lives - whether it's for a student loan, car loan, mortgage or loan to fund a business. To put yourself in the best position to get an affordable loan, you will need to understand and manage your credit score.

What is a credit score?

A credit score is a tool that lending institutions use to determine whether they will lend money to you.

The Consumer Financial Protection Bureau has a great article titled What is a credit score? explaining the details of a credit score: It is a prediction of your credit behavior, such as how likely you are to pay a loan back on time, based on information from your credit reports.

Why does a credit score matter?

Credit scores are important as they impact your ability to get a loan and the interest rate you will pay.

Based on your credit score, creditors determine whether they are willing to risk lending money to you - the higher your credit score, the more likely you are to be approved for the mortgage, car or any other loan for which you are applying. In addition to determining whether you will get a loan, your credit score impacts that interest rate you will pay. The higher your credit score, the lower the interest rate that you will pay - having a strong credit score can save you thousands of dollars of extra interest costs over your lifetime.

Nowadays, credit scores also impact more than just credit. Employers will often look at your credit score as a proxy for your dependability. If you don't have a good score, you may not get the job offer you've worked so hard to earn. Similarly, some insurance companies are now including credit scores in their underwriting - a weak credit score means that your insurance will cost more. Longer term, there may be other industries that start using credit scores so the importance of these numbers is going to continue to rise.

Understanding and managing your credit score can have a major impact on your finances and quality of life so it's worth understanding and managing.

How do credit scores get calculated?

Credit scores are complex calculations whose formulas aren't clearly enumerated by the three major bureaus in the US (Equifax, Experian, and TransUnion). However, they all rely on a combination of the following (details from What is a credit score? by the Consumer Financial Protection Bureau):

• Your bill-paying history
• Your current unpaid debt
• The number and type of loan accounts you have
• How long you have had your loan accounts open
• How much of your available credit you're using
• New applications for credit
• Whether you have had a debt sent to collection, a foreclosure, or a bankruptcy, and how long ago

Each of the credit bureaus has a different formula that incorporates these factors which they weight in their unique ways. There may also be other factors used by the bureaus, but the ones above account for the vast majority of one's credit score.

How do you find your credit score?

Credit scores historically were difficult to find and expensive. Fortunately, in 2003, the government started requiring the credit bureaus to provide consumers their score free of charge once a year.

You can access your score at AnnualCreditReport.com. This is a free site that enables you to get your scores cost free once a year from each of the three major credit agencies as mandated by law. It's important that you do so each year as the credit bureaus frequently have incorrect information. As you saw above, credit scores are a very important part of your financial health and you don't want a mistake by any credit bureau to negatively impact your score. If you find a mistake, the credit bureaus each have their own process where you can reach out to them and request that the mistake be rectified.

Each of the credit bureaus has a different formula that incorporates these factors which they weight in their unique ways. There may also be other factors used by the bureaus, but the ones above account for the vast majority of one's credit score.

How do you manage your credit score?

There are many ways to start building and managing a credit score.

The first step is to ensure that your score is correct. After that, there are many steps, all revolving around responsible use of credit, to maximize your score. These range from paying bills on time to not using too much credit relative to your income. My next article, which I will link to once it's complete, will provide more details on managing your credit score. Please keep an eye out for it.

This completes today's post on the importance of understanding and managing your credit score. The practical steps you can start taking from today's post are:

• Check your score: Once a year, check your credit score. Use AnnualCreditReport.com
• Ensure your credit reports are accurate: If there are any inaccuracies, contact the relevant credit bureau to fix any issues
• Take steps to manage and increase your score: There are many ways to improve your score with responsible credit management. This starts with paying your bills on time and includes items such as managing the amount of your outstanding credit. My next article will provide some easy tips to manage your credit, so be on the lookout for it

Thank you again for joining me on my journey to build financial literacy for young adults and their families. If you are interested in reading more of my posts, please access my author page (https://shopping-feedback.today/authors/sudhir-sahay) where you can see all the posts I’ve published. In addition, if you think any of your friends and family can benefit from this content, please share my profile page with them. If you have any questions on today’s post of if there are any topics you’re interested in my broaching in future posts, please let me know. I can be reached at [email protected].