What is Credit

Credit is a financial tool that allows individuals to borrow money or access goods and services with the agreement to repay the borrowed amount over time, usually with interest.

Why it matters

Overall Financial Well-being:

A positive credit history is an essential component of your overall financial health. It reflects your financial responsibility, helps you maintain a good reputation with lenders, and opens up opportunities for better financial options in the future.

Access to Loans and Credit:

Good credit allows you to qualify for loans and credit cards with favorable terms and lower interest rates. Lenders assess your creditworthiness before extending credit, and a positive credit history increases your chances of being approved.

Major Purchases:

When making significant purchases like a home or a car, most people rely on loans or mortgages. Lenders consider your creditworthiness before approving these loans, and having good credit can make it easier to secure financing.

Renting A Home or Apartment:

Many landlords and property management companies run credit checks on prospective tenants. A positive credit history can increase your chances of being approved for rental applications, while also reducing the required security deposit amount.

Employment Opportunities:

Certain employers, especially those in the financial sector, may review credit reports as part of their hiring process. A strong credit history can reflect positively on your reliability and responsibility, potentially improving your job prospects.

Insurance Premiums:

Insurance companies may consider credit information when determining your premiums. Research has shown a correlation between credit history and insurance risk, with lower credit scores potentially leading to higher premiums.

Utility Services:

Some utility providers may review your credit history before offering services like electricity, gas, or cable. Good credit can help you avoid the need for security deposits or additional requirements.

Building Trust with Lenders:

Establishing and maintaining good credit builds trust with financial institutions. It shows that you can manage credit responsibly, making it easier to access additional credit when needed.

Lower Interest Rates:

Good credit allows you to secure loans and credit cards with lower interest rates. This can save you a significant amount of money over time, especially for long-term loans like mortgages or student loans.

Financial Flexibility:

Having good credit provides greater financial flexibility. It allows you to take advantage of opportunities, handle emergencies, and manage unexpected expenses more effectively when borrowing money is needed.

credit report

Credit Reports

Credit reports, provided by major credit bureaus like Equifax, Experian, and TransUnion, offer comprehensive insights into one's credit history. They encompass personal details, credit accounts, payment history, public records like bankruptcies, tax liens, and credit inquiries. Regularly reviewing these reports is crucial for accuracy verification and fraud detection. These major credit bureaus offer monthly credit reports for free, while also providing paid services such as credit monitoring, identity theft protection and more.

credit score

Credit Scores

Credit scores are numerical representations of your creditworthiness, derived from the information in your credit reports. They are used by lenders to evaluate your credit risk quickly. The most commonly used credit scoring models are FICO® Score and VantageScore®. A higher credit score generally indicates lower credit risk and can help you qualify for better loan terms and interest rates.

FICO® Score: The FICO® Score range is typically between 300 and 850, with higher scores indicating better creditworthiness. Here is a breakdown of the FICO® Score ranges:
Exceptional: 800 and above
Very Good: 740-799
Good: 670-739
Fair: 580-669
Poor: 300-579

credit score calculation

How It's Calculated

Credit scores are calculated using various factors and algorithms, which can vary depending on the credit scoring model used (such as FICO® Score or VantageScore®). While the exact formulas are proprietary and not publicly disclosed, here are the general factors considered in calculating credit scores:

Payment History (35%):

This is the most significant factor in credit scoring. It looks at whether you have paid your credit obligations (loans, credit cards) on time, including any late payments, delinquencies, or accounts in collections.

Credit Utilization (30%):

This factor measures the amount of credit you are currently using compared to your total available credit limits. Keeping your credit utilization ratio low (typically below 30%) is generally recommended for better credit scores.

Length of Credit History (15%):

The length of time you have had credit accounts, including the age of your oldest and newest accounts, as well as the average age of all your accounts, is considered. A longer credit history generally improves your score.

Credit Mix (10%):

Lenders like to see a diverse mix of credit accounts, such as credit cards, loans (e.g., auto loans, mortgages), and retail accounts. Demonstrating responsible management across different types of credit can have a positive impact.

New Credit (10%):

This factor assesses your recent credit inquiries and new credit accounts. Opening several new accounts within a short period can lower your score. However, if you have a minimal credit history, responsible new credit activity can help establish a positive score.

buildingcredit

Building Credit

Obtain a Secured Credit Card:

If you're new to credit or have a limited credit history, a secured credit card can be a good starting point. Secured cards require a cash deposit as collateral, which becomes your credit limit. Make small purchases and consistently pay off the balance in full and on time to establish a positive payment history.

Become an Authorized User: 

If you have a trusted family member or friend with a good credit history, you can ask them to add you as an authorized user on one of their credit cards. Their positive payment history and credit utilization can help build your credit. Ensure that the credit card issuer reports authorized user activity to the credit bureaus.

Apply for a Credit Builder Loan:

Some financial institutions offer credit builder loans specifically designed to help individuals build credit. These loans typically require you to make fixed monthly payments into a savings account, and once the loan is paid off, you receive the funds. The lender reports your payments to the credit bureaus, helping establish a positive credit history.

Apply for a Starter Credit Card:

Certain credit cards are designed for individuals with limited or no credit history. Look for cards specifically marketed as starter or student cards.

Make Timely Payments: 

Paying your bills, loans, and credit card balances on time is crucial for building credit. Late payments can have a negative impact on your credit score. Set up payment reminders or automatic payments to ensure you never miss a due date.

Keep Credit Utilization Low: 

Aim to use a small portion of your available credit. High credit utilization can negatively impact your credit score. Ideally, keep your credit utilization below 30% of your credit limit. Paying off balances in full each month can help you achieve this.

Monitor Your Credit:

Regularly review your credit reports from the major credit bureaus (Equifax, Experian, TransUnion) to check for inaccuracies or fraudulent activity.

Avoid Excessive Credit Applications:

Applying for multiple credit accounts within a short period can raise concerns among lenders and may negatively impact your credit score. Be mindful of only applying for credit when necessary.

Establish Stable Employment and Residence:

Lenders may consider stability factors like employment history and residential stability when evaluating credit applications. Having a steady income and living in the same place for an extended period can positively influence your creditworthiness.

Credit Freeze

A credit freeze, also known as a security freeze, is a proactive measure individuals can take to restrict access to their credit report. When a credit freeze is in place, potential creditors cannot access your credit report unless you temporarily lift the freeze or remove it altogether. This can help prevent identity theft and unauthorized credit applications since lenders typically require access to your credit report before approving new credit accounts.