At first, the credit scoring system may seem confusing and unnecessary to learn more about. However, when you take the time to understand how your credit rating is generated, you will also learn how impactful it can be for your personal finance. You will also realize the value of improving your credit and the consequences of bad credit.
Simply building credit is not enough to ensure your financial health and establish creditworthiness. You need to work towards strong credit because lenders require good credit ratings to not only grant credit card and loan requests but to offer the best interest rates. In this guide, we will discuss the importance of credit and how it impacts your financial health and future.
Your credit score impacts your financial future
Lenders use your credit rating to decide whether to extend or deny credit. When you want to get a personal loan, an auto loan, a new credit card, or a line of credit, your credit score will impact the decision your lender will make.
While a low credit score doesn’t mean you will be automatically denied a credit card or loan, a history of poor credit management comes with consequences such as higher interest rates. If your loans are fixed for longer periods of time, this means a lot of money spent on interest alone. If you can’t get a lower interest rate from your lender, you will end up paying more than you should for almost every loan. Having a positive credit history helps with financial planning and means spending less on interest rates.
Benefits of credit scoring models
Your credit score is a number between 300 and 850, with 850 being the best score possible. To determine your credit score, credit bureaus consider factors like credit card usage and will analyze your history of paying for all forms of credit. The credit score analysis even involves student credit cards and student loans for those paying for college. They will also look into your monthly payments for real estate to mortgage lenders and credit unions.
Many factors affect your credit score, but your payment history accounts for 35% of your overall score. Higher numbers allow access to benefits like lower rates and fees on loans, but they aren’t achievable without a solid credit history.
While it may seem that scoring models only benefit lenders, they certainly help consumers as well. The previously discussed cybersecurity threat can be avoided by proper credit monitoring like Split® but also, maintaining a good score saves money in the long run. Lower interest rates provide more flexibility for consumers and better financial management for both sides. Scoring models also enhance speed and efficiency. Big data records are available to lenders, which enables them to make quick and accurate decisions while processing thousands of applications at a very fast pace. By providing accurate and timely data to lenders, financial risks are minimized since bad decision-making is kept at a very low rate.
Interest rates depend on your credit score
Interest rates on borrowed money vary depending on your credit score. As of March 2020, they can be as low as 3.217 % for people with FICO scores above 760 and go as high as 4.806 % for scores lower than 639. Keep in mind that these numbers are based on a 30-year fixed contract.
Lenders evaluate your risk factor based on your credit score, and five main factors influence it.
- Payment history
Payment history accounts for 35% of your total credit score. If you are paying your bills on time and have no negative public record for lawsuits, liens, bankruptcies, or foreclosure, you will be performing fine in this category.
- Credit utilization
Credit utilization makes up a total of 30% of your FICO score. Spending close to your credit limit would put you in a bad position. The FICO scoring system favors those who use up to 30% of their available credit. If you have a total limit of $1000 on your credit card, you shouldn’t be utilizing more than $300 if you are to expect a fair credit offer.
- Credit history
Your credit history accounts for 15% of your credit score. Owning a credit card for longer periods of time improves your score if you are paying it off every month.
- Types of credit (credit mix)
10% of your total score is determined by credit use. If you are using many different forms of credit (home loan, car loan, credit cards, mortgage), your FICO score will be higher. Credit bureaus are more willing to approve loans to people who handle more credit cards at once but don’t miss payments. However, applying for too many credits at once can be considered as a red flag.
- New credit
The last 10% of your total score is determined by new credit. Applying for a new card is OK unless you are asking for too many at the same time. Frequent credit requests send a message to lenders that you are paying off other credit by using a new one, and this is something they don’t take lightly.
Credit monitoring provides identity theft protection
One of the rising issues of the 21st century is data protection and identity theft. Cybercriminals that have access to your data can steal your identity and apply for credit under your name. You can only imagine what happens to your credit score if you become a victim. Enterprises have proven that they can’t securely handle big data, and the numerous data breaches in just the past few years have confirmed that. Without proper insight into your credit reports and scores, it could take days before you even realize that you are a victim of identity theft. Advanced solutions like Split® offers convenient credit monitoring along with Identity Theft insurance and fully assisted Identity Restoration. By taking matters into your own hands, you can react timely to such circumstances.
ID theft does temporary damage to your score, but it can take days and even weeks before you can fix your credit. It can be a time-consuming and frustrating process, especially for people who are in immediate need of business loans or any other lending services. Keeping a close eye on your credit reports helps you avoid all of this altogether. But don’t take Consumer Affinity’s word for it, Forbes talks about the importance of credit monitoring in this article.
Before reading this, you may not have realized how important it is to build good credit and improve your credit score. We hope that it is now more than evident how credit plays a significant role in many aspects of your life, from cybersecurity threats to money-saving situations. There are quite a few reasons why you should pay attention to those numbers and try to keep them as high as possible. By understanding the importance of your credit score, you can work to improve your credit profile continually.
Understanding credit scoring systems is essential if you want to have control over your future financial decisions. It’s alarming to realize how a late payment here and there on your credit card today can hurt your personal credit and ultimately affect mortgage rates on your future first home.
Apart from the standard services, Split offers education on topics like phishing, privacy, common scams, and best practice. Feel free to stop by our blog and learn how you can use your credit score to your best advantage.