Good credit, and the access it gives you to your work and financial life, has never been more important to success than it is today. Whether you’re planning to borrow for a high-value item like a car or house, or take out a credit card, your credit score will determine your down payment, your interest rate, and ultimately your monthly obligations.
But credit has also become a non-financial indicator of things like character, integrity, and responsibility. So, even if you think credit is a slippery slope and don’t intend to go into debt to buy something or even get a credit card, credit will still have a big impact on your life.
What is the importance of a good credit score?
What is your definition of a good life? A good job, a safe place to live, a car, financial security, maybe a good education for your children or even for yourself? Well, the reality of life in the US is that having a good credit history is essential to achieving goals like these and many more.
Rent an apartment or buy insurance
Many landlords regularly check credit reports and scores when looking at potential tenants.
In the case of insurance companies, they use what is called a soft call to help set rates; these are not requests that will affect the new credit portion of your account. Instead, your credit report is used to calculate their credit-based insurance score, which uses some of the information on your file to predict how likely you are to file a claim and how much you will be charged for your policy.
In particular, for these two purposes, your payment history will be very important in making a decision, but certainly not the only thing they will look at. In all of these non-lending situations, the decision maker may check your credit history as often as they check your references.
Eligibility for a loan
Of course, credit plays a big role in lending, determining whether you get a loan and at what price and under what conditions. For a great many Americans, getting a mortgage, buying a car (or any other expensive item), even going to college requires some or all of the cost of these things to be purchased on credit.
Unlike a grace plan, where you pay for an item for a set amount of time before taking possession of it, purchases on credit will come with an additional cost in terms of interest that you will have to pay. You don’t want to wait years to save up enough money to buy a house or a car with cash.
The kicker figures out how much that loan will cost you in the long run, and this is where your credit score comes into play. The better your credit report, the better your score, the better your access to low-cost loans. It’s really that simple.
Work searches
If it’s a really “good” job you’re applying for, chances are more than one person will apply for it. Some employers check your credit history to see if you are reliable or if you have financial problems at home that distract you. A credit report is a fairly reliable snapshot of your financial life and can be seen as a reflection of what kind of employee you will be.
How to maintain a good credit score
Maintain a solid payment history
Figuring out all the rules for a good credit score can be intimidating at first, but following some basic rules will go a long way towards building a good credit score. The golden rule is to pay all your financial obligations on time, as agreed, every time they fall due. If you can do this, you will be on the right track. This is because payment history is the number one factor in credit scoring. FICO considers this to be 35% of your total score.
Keep credit usage low
After payment history, credit usage comes in second with 30% of your FICO score. Usage refers to how much credit you use in relation to your credit limit. Having a credit card with a $5,000 limit doesn’t mean you have to go out and withdraw $5,000 right away, even if you plan to pay it back as soon as your bill is due.
Making the most of your card is one of the fastest ways to improve your credit score. Keeping your usage below 25% is important to your account; below 15% would be better, and even better would be to keep it in the single digits. That’s why successful FICO people, people with excellent credit scores, regularly have single digit utilization rates.
Specify the time of your credit history
15% of your FICO score is the length of your credit history or the age of your bills. This part is often the bane of young consumers because it’s simply not possible to customize this part. Your accounts are as old as they are and only time will help here.
Diversify your loan portfolio and limit the number of new loan applications
Finally, 10% each falls on the total of loans and a new loan. The credit mix looks at what types of accounts you have. It is better to have something more than credit cards, such as car payments or other fixed payment installment loans.
New credit shows how many new accounts have been filed in the recent past. Note that I said “applied” and not “approved” – the tricky questions are important in this part.
Tip: It is estimated that about 25% of credit reports contain errors, and these errors can damage your credit history. Therefore, it is important to check your credit reports regularly and remove any errors or outdated information. You can check your credit reports for free at AnnualCreditReport.com.
Difference between FICO and VantageScore
FICO is not the only credit scoring organization, although it is probably the best known. Another commonly used metric is the VantageScore. Its scoring matrix is slightly different, but it basically looks at the same components.
There are several differences in what is most important; for example, when payment history is most important to FICO, it is considered “moderately influential” by VantageScore. The more important elements are total credit usage, balances, and available credit (all “extremely important”). Loan composition and experience are also more important (“highly influential”) than payment history in the VantageScore model.
bottom line
In the end, how you manage your financial obligations matters. Whether it’s FICO or VantageScore, your credit score is responsible for opening (or closing) important doors in your life, from buying a house and renting a car to favorable credit terms and insurance premiums.
Editorial disclaimer
The editorial content on this page is based solely on the objective judgment of our contributors and is not based on advertising. It was not provided or ordered by credit card issuers. However, we may receive compensation when you click on links to our partners’ products.