When it comes to determining an individual’s creditworthiness or their tendency to repay their debts (such as loans, credit cards, mortgages, rent, etc.), a credit score is used. This numerical rating typically ranges from 300 to 800+, with a higher score indicating a lower lending risk. The use of credit scoring isn’t limited to just financial institutions; it’s also used in other industries, including employment qualifications, insurance, and even determining a person’s eligibility to rent a property.
In the mid-1950s, an algorithm for data analytics gave birth to what we now know as the credit score. Three decades later, it made its public debut on the NYSE. Today, the Fair Isaac Company, commonly referred to as FICO, has become the gold standard in the assessment of credit risk.
Your credit score is as important as paying taxes – it’s an inevitable part of life. Just like the IRS, it’s crucial to comprehend the regulations if you want to reap the benefits of a fairer playing field.
Credit Scores Fall Into Five Categories
Generating a credit score can be done using different methods, but two widely used algorithms are FICO and Vantage Score 3.0. These algorithms produce credit scores within a range that typically starts from 300, the lowest possible score, and goes up to a maximum of 900.
Credit can be classified into five categories, which may slightly vary based on the policies of credit reporting agencies.
Categories of Credit Scores
| FICO | Vantage 3.0 | ||
| Exceptional | 800 – 850 | Excellent | 781 – 850 |
| Very Good | 740 – 799 | Good | 661 – 780 |
| Good | 670 – 739 | Fair | 601 – 660 |
| Fair | 580 – 669 | Poor | 500 – 600 |
| Poor | Scores below 580 | Very Poor | 300 – 499 |
Credit scores can be a complex topic, and the small differences in credit categorization can only add to the confusion.
How a Credit Score is Calculated
In order to apply credit scoring techniques effectively, it is crucial to have a good understanding of the variables that are taken into account during the calculation process. Generally, credit scoring algorithms rely on five universal variables to establish the credit score.
Understanding the Key Components of Your Credit Score
Your credit score is a critical factor in determining your financial health. It is a measure of your creditworthiness and is used by lenders to determine whether or not to grant you credit. There are five key components that make up your credit score: payment history, amounts owed, length of credit history, credit mix, and new credit. Understanding these components is essential to maintaining a healthy credit score.
The first component is payment history, which accounts for 35% of your credit score. This component looks at whether you have made payments on time. Late payments, delinquencies, and defaults can all negatively impact your credit score.
Amounts owed comprise 30% of your credit score. This component looks at how much debt you have and how much of your available credit you are using. High levels of debt and a high credit utilization ratio can negatively impact your credit score.
Length of credit history accounts for 15% of your credit score. This component looks at how long you have been using credit. Generally, the longer your credit history, the better your credit score.
Credit mix comprises 10% of your credit score. This component looks at the different types of credit you have, including credit cards, loans, and mortgages. A diverse mix of credit can positively impact your credit score.
Finally, new credit accounts for 10% of your credit score. This component looks at how often you apply for new credit. Applying for too much credit can negatively impact your credit score.
In conclusion, understanding the components of your credit score is crucial to maintaining a healthy score. By paying your bills on time, keeping your debt levels low, maintaining a long credit history, diversifying your credit, and avoiding applying for too much credit, you can ensure that your credit score remains strong.
| Payment History | Reflects 35% of the score |
| Total Amount Owed | Reflects 30% of the score |
| Credit History Length | Reflects 15% of the score |
| Types of Accts. | Reflects 10% of the score |
| New Credit Lines | Reflects 10% of the score |
10 Tips to Learn How to Improve your Credit Score Quickly
When it comes to managing your finances, a credit report is a valuable collection of data and information that reflects how you have handled your finances over time. Your credit score is calculated based on the information in your credit profile, making it crucial to manage the content within it to improve your credit score. Therefore, learning how to improve credit scores entails effective management of your credit profile’s content.
1. Know What is on Your Current Credit Report
By law, every year, the three primary credit bureaus must offer consumers a free credit report. To obtain a copy of your free annual credit report, use the links provided below to contact the three major credit reporting agencies.
The Federal Trade Commission (FTC) suggests that consumers can obtain a free credit report from a provider that has been approved by the federal government, which is annualcreditreport.com.
2. Scan the Credit Report for Common Reporting Mistakes
Upon receiving the credit report, it is crucial to meticulously examine the information provided to identify any inaccuracies. Some of the most prevalent errors that could be present in the report are as follows:
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- Errors on the Balance Owed
- Incorrect Credit Limits
- Identity Mistakes – including misspelled names, erroneous addresses, or accounts opened fraudulently.
- Errors in Reporting – accounts appearing twice, reported as open when the account has been closed, or inaccurate reporting histories.
It’s not uncommon to come across errors when it comes to reporting, and it happens more frequently than most people realize. In fact, the Federal Trade Commission received over two million reports of fraud by consumers in 2020 alone. The top five categories that contributed to these fraudulent activities are:
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- Internet Service Provision
- Prizes
- Sweepstakes
- Lotteries
- Telephone/Mobile Services
According to the FTC, the 2020 fraud resulted in losses exceeding 3 billion dollars, marking an increase of over 83% in losses from the previous year, 2019.
3. Make Your Payments When Due
Your payment history is the most significant factor that affects your credit score. Essentially, it evaluates whether or not you consistently pay your bills on time.
Starting to pay your bills on time and when due can cause an organic increase in your credit score. By following the credit scoring rules, rather than resisting them, you can improve your score.
To avoid missing due dates, there are several apps and programs available that can help you set up reminders and alerts. Additionally, many banks offer automatic draft services at no extra cost, which can help ensure that bills are paid on time.
4. Be Proactive & Dispute Errors
In case you come across any inaccurate data on the report you have received, it is important to act quickly and get in touch with the credit bureau. You can initiate a dispute to rectify errors. Here are the relevant links that provide instructions and protocols for initiating a dispute –
It can be frustrating for consumers to have to disprove inaccurately reported data, but unfortunately, that responsibility often falls on them. In such situations, it is advisable to ask the company to provide written confirmation of any promises made. If the company is unwilling to do so, it might be best to consider alternative options or adopt one of the recommended strategies.
5. Implement a Payment Strategy
Late payment, or failing to make a payment altogether, can significantly affect one’s credit score. These delinquencies are typically recorded on a credit report for at least seven years. However, as time goes by, the negative impact of these late payments may eventually lessen.
Boosting your credit score can be achieved through various effective techniques. Consider these proven methods to help elevate your credit score.
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- Make payments to all outstanding debts on time and as agreed.
- Avoid allowing accounts to be sent to a collection agency/department, if possible. This is because having a few monthly delinquencies will do much less damage than a serious delinquency that hits a collection status.
- Improve how you use credit – this refers to one’s credit utilization. In other words, avoid opening and closing accounts when not necessary, and keep account balances below credit line maximums or limits.
6. Try to Credit Card Balances Low
Keeping your credit card balance under 30% of your credit limit is crucial to maintaining a good credit score. Once you approach or exceed your credit limit, your credit score can be negatively impacted. It’s important to remember that the ratio between the amount you owe and your credit line’s limit plays a significant role in determining your credit score. So, be sure to keep your credit card usage in check and stay within the recommended limit.
7. Use Debt, But Do So Responsibly
Using credit wisely is a crucial life skill that can help you in the long run, as long as you use it responsibly and make timely payments. Even if it’s just for monthly grocery or gas expenses, using credit can prove beneficial in improving your credit score. On the other hand, those who choose not to use credit may find it difficult to maintain a good credit score as there is no current data available to showcase their financial responsibility. Therefore, it is important to use credit judiciously, even for small expenses, to build a good credit history.
8. Do Not Open Multiple Credit Lines in a Short Time Period
When a consumer opens multiple accounts in a short period of time, it can appear risky to credit decision-makers. They may wonder if there is an underlying financial need that this new credit is intended to solve. Additionally, because the average age of credit accounts is a factor in determining credit scores, having more recent accounts can potentially lower the score unnecessarily.
9. Don’t Close All Accounts
When you accumulate a significant amount of debt at once, it can make your credit appear risky to lenders. Moreover, having new accounts can decrease the average age of your accounts and potentially have a negative impact on your credit score.
10. Don’t Give Up. Educate Yourself.
Looking for credit guidance? You don’t have to look far – it’s available both online and locally. Start your search by exploring government websites, where you can find detailed information on the topic.
The Bottom-Line
It’s important for consumers to know that they have the power to improve their credit scores. To make sure your credit report accurately reflects your creditworthiness, it’s recommended that you keep a close eye on it and learn effective strategies for boosting your score quickly.
As new data is added, credit scores are subject to change based on the most recent information available. While the tips mentioned earlier can help kickstart the process of improving your credit score, the biggest hurdle for many is staying patient throughout the journey.
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