In order to get better control of your credit, you need a good grasp on what credit is and how it works. Specifically, what are the key components of a credit score? Watch the video and download the Credit Myths: Discredited Guide as a guide and a place to make notes for what credit facts resonate with you.
How does the credit score break down?
Let's imagine you're getting ready to buy a car. You've saved a good portion of the money to pay for it, but you'll still need a loan to help purchase it from the dealer. Before any lender decides to give you a loan for the car, they will check your credit score.
Your credit score is made up of five key components:
- payment history (35%),
- credit utilization ratio (30%),
- length of credit history (15%),
- credit inquiries (10%), and
- credit mix (10%).
This data feeds into a credit report. The report basically indicates the level of responsibility with which you pay your bills and loans. If you have a history of consistently missing payments and maxing out your credit cards (without paying them down), you should anticipate a low credit score. On the other hand, if you make your payments on time and you stay under 30 percent of your credit limits, you'll have a higher credit score.
Budgeting tip: Credit scores range from 300-850. Higher credit scores are favorable to lenders but if you have a lower score, it's not the end of the world. You could make adjustments to improve your credit relatively quickly.
Have you ever wondered how you qualified for a loan? Or why you didn't? Perhaps you ended up with an interest rate higher than the one advertised. Your credit score may be the reason. It's a numerical scale that lenders use to determine your creditworthiness. The better the number, the more likely it is that you will get the credit you want at a desirable rate.
This credit score is often called a FICO® score, named after the Fair Isaac Corporation, a California-based company that developed software to compute the first credit scores. The FICO scoring method assigns a three-digit number ranging from 300 to 850 that can indicate to the lender the level of future risk based on your credit history.
How common are "good" credit scores?
According to the Fair Isaac Corporation, credit scores are typically spread among the population as follows:
- 32.2% of the population falls below 650,
- 13% of the population is between 650-699,
- 16.6% of the population is between 700-749,
- 18.2% of the population is between 750-799, and
- 19.9% of the population has a credit score above 800.
Understanding your credit score is the first step to financial success. It's a good idea to also monitor your credit report periodically, which you can do by receiving a free yearly credit report at freecreditreport.com.
Your chapter 1 checklist:
- Watch the Impacts to your credit: Payments, balances and credit history video,
- Download the Credit myths: Discredited worksheet, and
- Get an understanding of what credit is.
Watch the next chapter in the series: Credit truths.