What is a credit score and why is it important

What is a credit score?

A credit score is a number that lenders use to decide whether or not to approve you for a loan. The higher your credit score, the easier it will be to get approved.

There are three main types of credit scores: credit score, credit report and credit utilization.

• Credit score is a calculation of your overall credit worthiness based on this information. Ranked from 300-900 with the higher being the better score. 
• Credit report is just a list of your account information from different lending institutions – this includes your bank accounts, credit cards and loans outstanding and paid back.
• Credit utilization is how much of your available borrowing capacity you’re using each month – for example if you have a credit card with a $1,000 limit and you use 900, your credit utilization is 90%. As a rule of thumb, you don’t want this to be above 30% or it will lower your credit score. 

The three main credit scoring models are the FICO score, the VantageScore, and the PSQR. Each range corresponds to a different level of risk. The FICO score is the most popular and ranges from 300 to 850 which is often referenced when applying for a credit card, a personal loan or a mortgage. The VantageScore ranges from 501 to 990, and the PSQR ranges from 0 to 500.

Why it’s important

Your credit score shows the likelihood of you repaying your loan to the lender prior to them approving your for a loan or credit card. This is known as “underwriting”. Lenders will use your credit score to determine how risky it is to lend a person money and wether they are likely to pay it back. The higher your credit score the less risky you are and the lower your credit score the more risky your are. The higher your score the better your chances of approval when applying for a loan or credit card.

It is important to have a good credit score so you can get the best rate and terms on your loans and have the highest chance of approval.

What is a good credit score?

A good credit score is usually anything above 700 on the FICO scale. Anything above 620 on the VantageScore scale is also considered good. You can check your credit score free at creditkarma.com 

Credit score ranges vary based on the credit scoring model used, but are generally similar to the following:

• 300-549: Poor
• 550-669: Fair
• 670-739: Good
• 740-799: Very good
• 800-900: Excellent

How is a credit score calculated?

When you have a credit card or a loan, you are required to make monthly payments towards paying off that debt. When a payment is made, the bank or institution will report that to the credit bureau such as Equifax or TransUnion. The same is done if you miss a payment or don’t pay back your loan at all. This information is kept on record and depending on your history of repayments (your credit history) a score is calculated, known as your credit score. This number ranges from 300 to 900, with higher numbers indicating a lower risk of being rejected for a loan.

A good credit score tells lenders that you’re likely to repay your loans in a timely manner. A low credit score means that you are less likely to pay your loan or credit card back and meaning that you are higher risk and lenders are more likely to require high interest rates when you apply for a loan.

What can affect a credit score?

There are main factors that influence your credit score:

• Late payments 
• Credit history
• How much debt you have
• How long it has been since you last paid off your debts
• Credit utilization ratio

Types of credit scores

There are two types of credit scores: the “credit score model” and the “risk score.”

The credit score model is the most common type and looks at your entire credit history. It includes information such as your total debt, how long it has been since you last paid off your debts, and how much credit you use each month.

The risk score takes into account only your current debt situation and how risky that debt is based on your credit history. This is important because some high-risk loans, such as car loans, can have a greater impact on your overall credit score than lower-risk loans.

How can I improve my credit score?

There’s not one easy answer to this question, since there are a variety of things you can do to improve your score. However, some things you can do to improve your score include:

• Use Chime to build your credit: Chime is a secured credit card which is like a debit card but it reports payments to the TransUnion, Equifax and Experian credit bureaus like a credit card would. This will increase the positive payment records on your credit history and increase your credit score. 
• Paying your debts on time: The easiest way to improve your score is to activate automatic monthly payments on your credit cards and loans so you do not miss a payment. 
• Increasing your credit card limit: By increasing your credit card limit you decrease your credit utilization ratio which will positively affect your credit score
• Use credit monitoring: Credit monitoring will notify you of any soft or hard credit checks on your credit. These checks temporarily decrease your credit score when you apply for things like credit cards and loans. You’ll only want to apply when you know your chance of approval is high.

Here’s a great info graph from bestegg:

How can I find my credit score?

There are several ways you can find out your credit score. Banks often have an option to see your credit score for free. Not all banks do this and it can be hard to find.

Another way is to go to the credit bureau’s website and open an account. You can also get a free credit report from each of the three major credit bureaus every year.

You can also check your credit score for free every month on CreditSesame or CreditKarma.

Can I get a loan if I have bad credit?

Yes, you can get a loan if you have bad credit. However, the interest rate you will be charged will be higher than for someone with good credit. You’ll also have to meet certain eligibility requirements, such as having a good credit history and a low debt-to-income ratio. 

Here are the best loans for bad credit:

5KFunds	Urban Bad Credit Loans	CreditNinja Personal Loans
Est. APR 5.99-39.99%	Est. APR 19.99-300%	Est. APR 199-349%
Est. Loan Term 61 days – 72 months	Est. Loan Term 18-60 months	Est. Loan Term 2-18 months
Loan amount $1,000 – $35,000	Loan amount $250-$5,000	Loan amount $250-$5,000
Min. Credit Score 500	Min. Credit Score 500	Min. Credit Score 500
Min. income $1,200 per month*	Min. income $1,200 per month*	Min. income $1,200 per month*

If you are in an emergency and need cash fast, you can apply for an instant payday loan with easy approval but these should only be used as a last case scenario. 

Wrapping up 

Understanding what a credit score is and how it will affect your financial future is an important step to taking control of your finances. If you have less than excellent credit following these tips you will be able to increase your chances of getting approved  for a credit card, loan or mortgage.