Credit Score
Another principle of financial literacy that everybody should be thinking about is proper management of their credit score. Your credit score is a number between 300 and 850 that is calculated to provide lenders, financial institutions, and other groups or individuals a measure of your credit risk. In short, your credit risk represents the likelihood that you will pay back the money you owe.
Your score is calculated from a multitude of different sources that are usually found on your credit report. These sources report your payment history, how much you owe, how much you have paid, if you have ever been late on a payment, the length of your credit history, and other data points related to your use of borrowed funds. Lenders see you as a good credit risk when you have a high credit score and are more likely to lend to you with favorable terms. A lower score does not mean you won't be approved for a loan or credit, but it may mean that you have to pay a higher interest rate or come up with more of a down payment. A very low score could potentially stop you from being able to get credit or be approved for loans.
Here is a general look at credit score ranges:
300-579: Poor
580-669: Fair
670-739: Good
740-799: Very good
800-850: Excellent
One sometimes confusing aspect of credit scores that you may not know about is that you will have different scores depending on the type of credit you are applying for. It is in your best interest to ask potential lenders what score they will be using so that you can be sure you have a score high enough to be approved for whatever it is you are applying for. If you are buying a car, the lender may run a more focused report on your payment history with installment loans. If you are applying for a credit card, the card issuer may look more closely at your history of credit card payments. Basically, different lenders will have different ways of evaluating your credit score, so be sure to ask questions or do a little homework ahead of time.
Why are credit scores important?
When you have an excellent credit score you will receive the most favorable terms and conditions on financial products. This could potentially save you tens of thousands of dollars in interest payments over your lifetime. This savings is then available for you to use in other areas of your life that matter. Maybe you bulk up your savings, perhaps you treat yourself, or maybe you can even save for that vacation you have always wanted. No matter how you spend the savings on interest, it is always better to potentially finance a car at 0% interest rather than 4%.
Another important consideration is the access to certain things that your credit score may impact. It is not uncommon for residential properties to require a minimum credit score to live in their properties. It is also commonplace for employers to check your credit score if you want to work for them. Think about the impact that a poor credit score could have on you if you cannot secure housing or employment.
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As you can see above, the most critical factors in calculating your credit score are your payment history and the amount that you owe. It is in your best interest to pay all your obligations on time and in full if possible. Missed payments, late payments, and carrying large balances will be detrimental to your credit score.
There are three main credit score reporting agencies: Equifax, Transunion, and Experian. Sometimes your score will differ between these three agencies and that is normal. Differences in scores are usually attributed to the timing of the report data and the fact that some lenders or creditors may only report to one agency and not all three. Sometimes a lender will use all three of your scores to determine your creditworthiness.
Credit scores can seem confusing at times. The best way to ensure that you are always in the best position possible from a credit perspective is to pay attention and monitor your score, do your best not to acquire debt you cannot easily pay back, and always pay your debts on time. By taking these simple steps, you will be building a solid credit history.