You may have heard someone talk about credit or credit scores, and you might not know how they work. There is no need to be embarrassed since understanding how credit scores work can be pretty complicated. One in every five Americans between the ages of 20 and 29 don’t know their credit scores. In this article, we will answer four commonly asked questions about credit so that you can improve your understanding and use it to increase your financial power.
1. What Is Credit?
The term credit generally refers to a contractual agreement between a borrower, and an institution, where the borrower receives money from the institution with the intent of repaying it later, often with added interest. However, when the average person refers to credit, they are referring to credit history or credit scores.
When applying for large loans for purchases such as houses or cars, the institution handing out loans will look at your credit score and history. A good credit score makes acquiring these loans at lower interest rates easy.
2. How Are Credit Scores Calculated?
Your credit score is an essential measure of your credibility as a loanee. The most widely used credit scores are FICO and are called FICO scores. They range from 300 to 850, with 300 being the lowest and 850 being the highest. Although FICO does not reveal the algorithm it uses to calculate your score, it incorporates five components with differing levels of importance. These five components, along with their weighted effects on your FICO score, are:
● Payment history (35%)
● The amount owed (30%)
● Length of credit history (15%)
● New credit (10%)
● Credit mix (10%)
Generally, a FICO score upwards of 670 is considered a good credit score, but some institutions may have their own benchmarks for what constitutes a good credit score.
3. How Can You Fix Your Credit Score?
Unfortunately, rebuilding or boosting your credit score has no instant fixes. It requires consistent, intelligent financial behavior over a prolonged period. Some methods you can adopt to help improve or establish your credit score are:
● Avoid making late payments: Your payment history is the lynchpin of your credit score. Try to make all your payments on time and in full.
● Refrain from opening new accounts: When you open a credit account, you can decrease the age of all your accounts. Though one new account won’t matter much, if you open several new accounts, the effect can compound and noticeably reduce your credit score.
● Regularly review your credit reports: This can help you keep track of your accounts and debt. It also alerts you to any potential errors or fraudulent activity.
● Keep your debts low: Your credit score calculates what percentage of your credit score you use. Keeping your credit usage below 30% is generally considered good.
4. Is It Possible to Build Credit Without a Credit Card?
You can build credit without a credit card since credit card companies are not the only companies that report your payment history to the credit bureaus. Activities such as purchasing tradelines or paying federal loans under your name also build your credit. Some rent and utility companies also report your history, which can work toward building credit.
Gaining good credit is a part of your financial power and can significantly ease getting a loan for your dream house. Understanding how credit works and how to improve it will help you financially in the long term. We have hopefully provided enough information to help you understand how your credit scores work and how to improve them if they are dwindling. Using your credit responsibly and conscientiously will make it easier to achieve your financial goals.