Money 101: The Layman’s Guide To Understanding Your Credit Score

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If you’ve ever taken a loan, you must have a fair idea of your credit score. However, if you have never heard about it, this article will help you with understanding your credit score–the meaning and why you need it.

Every lender (individual or a financial institution) takes time to find out the borrower’s credit score before lending money. A credit score helps them to check your credibility and performance.

It’s a three-digit number, ranging from 300-850. Your credit score builds an impression of your commitment to paying off your installments on time. As a consequence, errors in your credit report could hamper your chances of getting loans and advances in the future.

A credit is a transaction in which one party (the lender) allows another party (the borrower) to access whatever they need without paying for it immediately. Both parties enter into a contract that defines the scope of repayment of debts incurred by the borrower and the time by which repayment is due.

The credit score is usually calculated by investigating your previous credit history and credit report. To successfully access any credit purchase or have a functional credit card, you need to have an impressive credit score. The higher your credit score is, the more likely you can get a loan. On the other hand, if your credit score is low, accessing further credit funds may be challenging.

How is your credit score calculated?

Your credit score is the result of your previous credit transactions. Your three-digit credit score is obtained after considering 5 of these aspects.

Payment history

Your payment history record shows if you repay your credits on time. In addition to that, it also covers how much you owe, the number of times you missed the deadline, and how much time you took to cover it.

A credit card on an apple phone

The payment history accounts for 35% of your entire credit score. If you have a clean history of repaying your credits on time, your payment score will be high. Bad payment history can lead to a lower credit score.

Amount owed

This is a cumulative figure obtained from examining the history of your credit cards and the loans you have taken from financial institutions. The figure obtained is compared against the total amount of credits available to you.

A higher amount owed will ultimately reduce your credit score. This factor is responsible for 30% of your entire credit score.

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Types of accounts you hold

The types of accounts you hold play a major role in the determination of your credit score. It improves when you have more types of accounts to your name.

These accounts range from credit and retail card accounts to home loans and other forms of loan accounts. 10% of your credit score comes from the account types you have.

Duration of credit history

If you have a long history of making your credit payments at the right time, you have a better score here. The duration of your credit history contributes 15% to your entire credit score.

recent credit activities

Applying for multiple credit sources or holding multiple credit cards is indicative of a looming financial crisis. Your credit score will be negatively affected under these conditions.

An american express business card with a lock in front of it

On the other hand, holding a few credit cards, repaying credits at the right time, and resolving differences with lenders are indicators of healthy credit activity.

Your most recent credit activities make up the remaining 10% of your credit score.

Implications of your credit score

Once you have found your credit score, compare it against this table to better understand the implications.

Credit score above 750:

This is an excellent credit score. It shows that you have had a great history of repaying credits at the right time and have avoided credit blunders. This pace suggests that there isn’t a financial apocalypse in your near future.

From 700-750:

This is a good credit score. Lenders wouldn’t have a hard time granting you extra credits as you have a track record of upholding your end-of-credit bargains.

From of 650-700:

This is considered a fair credit score. It is a sign of a few credit blunders, including missing out on repayment deadlines and holding multiple credit cards.

From 700-650:

This is a bad credit score. Under these circumstances, it may be difficult for you to access further credits until your score improves.

Below 600:

This is taken as very bad credit. Think of it as the no-no red flag that will make lenders run away when you need a loan.

Two credit cards laying on table near an ipad

A credit score in this category suggests many things, including a history of not making credit repayments on time, falling into multiple credit blunders, and holding many credit cards which have all been maxed out.

Under these conditions, it is almost impossible to access new credits. The best action line would be to work on improving your credit score.

How to improve your credit score or keep it from falling further

Here are a few actionable steps to help you improve your credit score.

Stick to the contract.

Stick to repayment deadliness as much as possible. Missing these can reduce your credit score.

Use payment reminders.

It is very easy to forget to pay the dues on time. So, set up payment reminders to avoid this from happening.

Review your credit history.

There are three major bodies responsible for curating and calculating credit scores. These are known as Credit Bureaus, and they are; Experian, TransUnion, and Equifax.

A credit card sitting on a laptop

Thankfully, according to the Fair Credit Reporting Act (FCRA), every adult is entitled to one free credit report per annum. Obtaining this report from any of the Credit Bureaus and going through it will help you know your credit score. If it is low, you can start working on upgrading it.

Do not apply for new credit accounts unless necessary

Having multiple credit accounts (especially when they are all maxed out) can serve as a red flag and greatly reduce your credit score.

Pay the credit on maxed out cards immediately

Before you begin paying for credit accounts that aren’t yet maxed out, focus on paying the debts accumulated on your maxed-out credit accounts. This is a way of reinforcing lenders’ trust and can greatly increase your credit score.

Apply for 0% interest cards

A 0% interest card can make a lot of difference in your credit score. It means that you wouldn’t accumulate extra funds as a result of interest.

However, finding this option can be somewhat challenging because only a handful of companies offer such cards. Besides, the 0% interest cards are usually only available for people with excellent credit scores (above 750).

Summary

Understanding your credit score is necessary because it will help you access more funds when you need them. Also, the activities that help you build a healthy credit score can help you develop financial discipline.

To apply for a personal loan, understand the best type of personal loan for your needs. To accurately calculate the costs associated with a personal loan, click here.

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