Everything There Is To Know About Credit
Whether you’re thinking about buying a car or applying for a mortgage, you’ll need to have strong credit to get approved and get a low interest rate.
Even if you’re just looking for a job or apartment, having a low credit profile, meaning you don’t have enough credit history to generate a credit score, can prevent you from outscoring other applicants in the process.
Credit scores are also used when you need to borrow only from banks.
A low credit score can mean that insurance companies, telephone service providers, and other businesses charge you higher rates or additional fees.
Building a good credit score can be challenging, especially if you’re just starting out or have minimal credit history.
Unfortunately, many of our clients face this problem when they move abroad to seek new opportunities in another country and need to establish themselves.
However, there are ways you can build a good credit history from scratch. While it may take time, your efforts will show banks, landlords, and potential employers that you are a good prospect.
First of all, it is important to know everything that can be part of your credit score.
What is credit?
Credit is borrowed money that you must pay back, usually with interest.
If you need to make a large purchase and you don’t have enough cash, a credit can help you achieve your goal and pay for the purchase in installments.
There are two types of credit: term and revolving.
Installment credit is a loan in which you pay an installment each month and there is an established payment period at the beginning.
Most loans, including mortgages, auto loans, student loans, and personal loans, are examples of installment credit.
Revolving credit allows you to use a line of credit up to a certain limit, pay it off, and use it again. There is usually a minimum monthly payment, but there is no set payment term.
Credit cards, home equity lines of credit, and personal lines of credit are forms of revolving or revolving credit.
As you use installment or revolving credit frequently and responsibly, you establish a credit history, which is recorded in your credit reports.
Your credit score is a numerical representation of that history and gives potential creditors an idea of how responsible you are when using credit.
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The difference between credit scores and credit reports
There are generally three credit bureaus in the United States that issue credit reports: Experian, Equifax, and TransUnion.
When you get a loan or use your credit card, the company that issued the credit typically reports your account activity to each of these three credit bureaus;
who then organize that data into your credit report.
Credit scoring companies, like FICO and VantageScore, use complex scoring models using the information in your credit reports and give you a credit score based on that information.
FICO and VantageScore credit scores range from 300 to 850. However, 90% of major credit providers in the United States use the FICO score , so it’s generally the one you want to know about.
The VantageScore, which is used by many free credit monitoring services, uses the same factors as FICO in its calculations. Therefore, both scores are very similar.
To summarize, your credit reports show your actual credit history, while your credit score is a representation of the information found in each report.
What is considered a good credit score?
When you apply for a loan or credit card, you’ll commonly notice that a credit company lists a range of interest rates. This means that the rate you can get depends on your creditworthiness, which includes how good your credit score is.
Depending on the source, you may see different credit score ranges. That’s because different companies have various interpretations of what they consider to be good credit.
According to FICO , this can give you a good idea of what the ranges look like:
- Exceptional : 800 to 850
- Very good: 740 to 799
- Good: 670 to 739
- Intermediate: from 580 to 669
- Poor : 300 to 579
You can take into account that the average FICO credit score in the United States is 700.
How is a credit score calculated?
Your credit score is calculated based on five factors, with some weighing more heavily than others.
1. Your payment history
Your payment history makes up 35% of your FICO credit score, making it the most important factor in your credit history. Basically, this indicates whether you have made your payments on time.
If you always pay on time, your credit score will reflect positively. But if you make late payments or allow your accounts to become delinquent, both your payment history and your credit score will suffer.
2. How much do you owe?
If you want to borrow money in the future, but you already have a lot of debt, lenders may deny your request.
The same is true if you have a high balance on one or more of your credit cards.
In fact, there’s a factor called credit utilization ratio, which credit scoring models use to determine if your credit card balance is too high.
If your credit utilization is simply your balance divided by your credit limit. So if you have a $2,000 balance on a credit card with a $5,000 limit, your credit utilization ratio is 40%.
To improve your credit, try to keep your credit utilization ratio as low as possible, preferably in the single digits.
This can be difficult at first if you have a low credit limit, but it will get easier over time when you qualify for better credit cards with higher limits.
This factor makes up 30% of your FICO credit score.
3. Age of credit history
Essentially, this represents how long you have been using the credit. Since you are just starting out, building this part will take time and patience.
But the good news is that it makes up only 15% of your FICO credit score, so it’s not going to significantly contribute or hurt your credit.
In addition to considering your oldest credit account, another figure used by credit score calculation models is the duration of the credit.
The history is calculated through the average age of accounts. For example, if you open a new credit card account today, the average age of your accounts is one month.
However, over time that average will grow. Once you apply for another card or loan, the average will include the age of both accounts, causing it to go down.
As a result, it’s best to avoid opening new credit accounts unless necessary. Otherwise, you could lower the average age of your accounts and hurt your credit score.
4. Combination of credits
Lending companies like to see that you are able to manage multiple types of credit. For example, having a credit card, a car loan, and a mortgage is better than having just one of these.
However, this factor only makes up 10% of your FICO score, so don’t go out and get multiple loans just to boost your credit score.
It is best to work on this over time as you will naturally need different types of loans.
5. New credits
This factor tells companies how often you’ve recently applied for credit and is based on the number of “hard” inquiries your credit reports have.
When you apply for credit, a detailed investigation is done and a company verifies your score.
That means checking your own credit score or having your history reviewed by potential landlords or employers won’t negatively affect your credit score.
The same is true if a company checks your credit to send you a pre-approval offer. These types of queries are called “soft” queries.
Hard inquiries remain on your credit report for 24 months, and their impact makes up 10% of your FICO credit score.