What is a Credit Score and Why Should I Care?
Your credit score is a three-digit measurement of your creditworthiness. By summarizing your prior history of paying off your debts, your credit score tells potential lenders how much risk they will assume if they grant you a loan.
If you are considered a risky borrower, your loan application may be declined, or you may have to pay more for that loan. In the case of mortgages, those higher costs can be applied two ways – by requiring a higher borrowing rate for your loan and possibly requiring mortgage insurance.
What is a Good Credit Score?
Credit scores usually range from 300 to 850, with four broad categories:
- Bad Credit – 300-650
- Fair Credit – 651-700
- Good Credit – 701-759
- Excellent Credit – 760+
The higher your score, the better (lower) rates you can secure. The lower your credit score, the higher your cost of borrowing money and the slimmer your chances to obtain a loan when you need one.
How Credit Scores are Determined
Payment History – The most significant determinant of your credit score is your payment history. So, don’t be late on payments to credit accounts, utilities, or any other bills.
Debt Load – How much you owe is the second most important consideration. Don’t overextend yourself in the credit department. Keep credit lines reasonable in relation to your income. For the debt you do carry, try to keep it at or below 10 percent of the total credit line.
Credit History – The longer you have been using credit (and paying it off in a timely fashion) the better your score. Establish your credit early and, when possible, keep accounts open.
Type of Credit – Having a variety of credit types, including mortgage, revolving credit, personal loans, auto loans, etc., will show you are a better risk.
New Credit Inquiries – Every time you open a credit card or apply for a loan, the lender will formally request your credit record. These inquiries have an immediate and adverse effect on your score, although the impact is small and temporary.
Don’t let this sway you from securing a new credit line that will improve your overall score, but do consider your timing. For example, it’s a bad idea to borrow money to pay for new appliances right before for your lender is finalizing your mortgage application and reviewing your credit rating.
Credit Scores are Individual
You may share a home with your spouse, but you do NOT share a credit score with anyone. Credit scores are individual measurements and evaluations of one person’s credit history.
That said, your credit score will be hurt or helped by any loans or credit lines you have secured WITH other individuals, including co-signing on someone else’s loan. Your credit score is yours, and yours alone. Protect it.
Why You Should Care
It’s essential to start working on your credit score as soon as you can, or you may not be able to borrow money when you most want and need it—to buy a car, for example, or to purchase your first house. Few people have enough liquid assets to pay cash for a car, or a home, and will need to borrow money to finance these purchases.
The better your credit score, the less that loan will cost. The total price of your home can be reduced by thousands of dollars over the life of the loan if your credit score is excellent, instead of poor or good.
It’s always better to establish good credit early, so you will be able to secure the best possible interest rate when it’s time to obtain a mortgage to buy a home.
Your credit score can also impact other loans, credit card applications, the cost of your insurance policies, your ability to open utility accounts, and even your job applications!
Learn even more about credit scores.