Oh, credit scores. A necessary evil in the adult world and something that no one really teaches us about. A credit score is your password to unlock all sorts of financial opportunities. Your credit score can help you get a car loan, get approved for an apartment or a mortgage, and buy a killer rental property with a lower interest rate.
I’m here to help you understand just what a credit score is, and how you can improve your credit with actionable tips! It doesn’t have to feel like you’re going to war, but if it does, I’ll fight right along with you.
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What is a credit score?
A credit score is a number that ranges anywhere from 300-850 that is used by all sorts of companies (car companies, banks, government agencies, landlords, etc) to decide if they should lend you money. They use this number to determine the probability that you will actually pay back the money you owe them.
Banks and other lenders have one goal, to get back the money they lend out. Nobody is in the financial sector to lose their money. This is why people with bad credit get a higher interest rate, because they have a lower chance of paying it back so the companies are able to get more money out of you through the interest you pay monthly.
You need to think of your credit score as a level of trust a bank has in your ability to pay back your loan entirely. There are 5 ranges that you can be in from your credit score, they range from bad to excellent. The goal is to see yourself in the top two sections if you want to receive all the perks of a good score.
Why is your credit score important?
Unless you’ve got a ton of family money, loans from a bank are just going to be a regular part of your life. You’ll need car loans, home loans, and maybe even a line of credit.
Having a good credit score can drastically improve your life because companies are going to be willing to give you a lower interest rate which can give you more money to spend on things you want and investing to make yourself more money.
Where can you see your credit score?
Let’s be real, I’m cheap. I don’t want to waste money on anything that I can find somewhere for free. That’s why I’m a huge fan of credit karma. You can see a soft inquiry of your credit score whenever you’d like, for free.
When you ask for a credit score from most companies, it’s going to what’s called a hard inquiry. This means that your credit score will actually decrease when they send you a report!
How is your credit score calculated?
Your credit score is made up of 5 categories that all make up a different piece of the credit score pie:
- Payment History
- Total Amounts Owed
- Length of Credit History
- New Credit
- Types of Credit
Let’s dig a little deeper into each of these 5 categories so you can understand how they work:
#1 – Payment History
This factor is the most straightforward of the bunch. Payment history refers to whether or not you’ve paid your credit accounts on time and in full. It takes into account your entire payment history. It includes the ratio of on-time to late/missed payments, collections that are against you for unpaid credit, as well as liens, bankruptcies, foreclosures, etc.
#2 – Total Amounts Owed
The total amounts owed is all about your credit utilization and the total amount of money you owe on credit. Your credit utilization is how much of your available credit you’re currently using.
For example, if you have a credit card with a $1000 limit and you have $975 charged to that card, your utilization is going to be 97.5%. This means that you’ll be viewed more negatively in the eyes of a lender because they see it as irresponsible and they may question your ability to make your minimum payment.
#3 – Length of Credit History
The longer you’ve proved that you’re able to handle credit, the better your credit score is going to be. Obviously, this percentage of your credit is just going to increase as you get older which is unfortunate for those of us who are young.
This is a big reason why it’s super recommended to start using credit when you turn 18 and have the option to!
#4 – New Credit
Every single time you apply for credit, there is a “hard inquiry” on your credit score. This means every single time you apply for a credit card, a mortgage, a car loan, etc. you’re going to see a decrease in your credit score.
It’s a pretty big bummer, but it’s how it works.
#5 – Types of Credit Used
Creditors want to see that you don’t only have 10 credit cards. They want you to look like a well-balanced human! They want to know you’re borrowing responsibly and not just racking up credit card debt!
They prefer to see that you have a mortgage or a car loan, instead of having a ton of credit cards, etc.
How to Improve Your Credit Score
It may sound super daunting to try and improve a bad credit score, but it isn’t impossible. There are seriously easy things you can do to improve your score and get in that coveted 800 credit score club. #Goals
#1 – Pay Down (Not Off) Your Balances
This one is often a bit controversial. There are a lot of financial people out there that say you should just pay off your debt completely because why would you ever want to carry it from month to month?
Well, a 0% credit utilization score isn’t actually seen as favourable to a lender because that means they make no money off you!
An ideal credit utilization percentage is around 30%. This means that if your credit limit is $1000, you want to carry a balance of around $300 or less month to month.
#2 – Decrease Your Utilization
There are two ways to change your utilization, but I’ll only ever suggest the second.
The first, is to increase your credit limits. This means if you have a card with a limit of $1000 but you have $900 of charges on it, your utilization is 90%. If you were to increase the credit limit to $5,000 then your credit utilization would only be at 18%. The downside to this is that many people will start to spend more money because it’s available to them.
The second, is to decrease your balance so your utilization is less without having the option to spend more money.
#3 – Keep Unused Accounts Open
Even if you don’t use a card, it’s a good idea to keep it open. Even if you have a 0 balance, having a card open will keep your length of credit history longer.
You can do a thing where you charge a very small amount on the card every month and pay the balance off without a problem!
#4 – Avoid Hard Inquiries
If you need credit, don’t apply to 10 accounts all at once. It’s never a good idea! Every time you apply it’s going to ding your credit just a little bit and by the 10th card, there’s a very low chance that you’ll even be accepted.
Unless you know that you’ll be accepted into whatever you’ve applied for, maybe don’t apply.
#5 – Use a Secured Card
If you have really horrible credit, your only option may be a secured credit card. A secured card is given out by a bank with you paying an amount of money up front.
This money is usually the same as the credit limit amount on the card. The lender uses this secured money to pay off your balance in the chance that you default. Secured cards are a great way to increase your credit slowly, but surely. It’s all about small changes in the right direction.
#6 – Try Not To Move
This is one of those things that people don’t usually know about their credit score. Your recent addresses are all going to appear on your credit report!
If you’re moving every few months or even every year, the lender is going to see that when they pull your credit score. This means they are going to see you as less trustworthy because they’ll assume you were unable to pay rent and that you were evicted!
Credit scores don’t have to be complicated. There are simple, actionable steps you can take to improve your credit at least 100 points in only a few short months. I’ve done it! My credit dropped a ton last year because I made a few bad decisions and I brought it right back up 100 points in just 4 months. It’s difficult, but not impossible.