What is a Credit Score?
If you're starting on your journey to financial freedom & financial literacy, you might've heard about something called a Credit Score. If you're ever planning to borrowing money to purchase a home or a car then you need to understand what a credit score is & how it affects you.
Your credit score, aka FICO score, is a three-digit number derived from a mathematical algorithm using information in your credit history. In other words, it's a snapshot of your personal borrowing and repayment history. Lenders (and sometimes, landlords, companies & utility companies) use this score to assist them in determining the risk of lending you money. Your score will range somewhere between 300-850. The higher your score, the more likely you are to be approved for a loan. Adversely, the closer you are to 300, the more you are considered a high risk.
How is your Credit Score calculated?
Going into the equation of calculating your credit score can be complicated, so let's simplify it to make it less scary.
Payment History: (35%) Did you make payments on time?
Amount Owed: (30%) Do you have $900 loan, or $9,000?
Length of Credit History: (15%) Have you had a credit card for 5 years, or 5 months? How often do use those them?
Types of Credit Used: (10%) What kinds of accounts do you have? Installment (ex. auto/student loan, mortgage), revolving (ex. credit cards, lines of credit)?
New Credit: (10%) How frequently have you applied for credit?
All this information, which is contained in your credit report, determines your credit score. When a company or organization needs to check your score, they generally will check with one of the three main credit bureaus; Experian, TransUnion, and/or Equifax. Since these credit bureaus are separate entities, it’s possible that one or all of them might not have all of your information. This can negatively affect you if a lender gets an inaccurate credit score for (this can lead to higher interest rates for you To ensure accuracy, you can contact any/all of the bureaus and request a copy of your report. If you find any errors, you can contact the reporting agency again to correct the mistakes.
Your credit score is a representation of the likelihood that you will repay your debt. The list of people/organizations that use your credit score can include credit card companies, banks, credit unions, financing companies, mortgage lenders, landlords, utility companies, cell phone companies, etc. You can safely assume that it's vitally important to be knowledgeable about your score, and what is affecting it.