A credit rating provides a quick snapshot of someone’s financial habits regarding their credit accounts. Credit ratings are usually called credit scores, which come from the three credit reporting agencies for consumers: Experian, TransUnion, and Equifax. Generally, you will have three ratings or scores each from one of the major credit bureaus. Your credit rating/credit score is vital to your finances and beyond.
Continue reading more about credit ratings, how they can impact you, and the different details about credit ratings/scores.
What Does a Credit Rating Encompass?
A credit rating factors in several different variables that have to do with credit, income, and general financial habits. Here are the significant factors that determine credit scores:
Payment history makes up about 35% of your credit scores. Your payment history refers to how you make your payments. This is the most significant factor that impacts credit ratings/credit scores. How you pay your credit accounts may be reported to the credit bureaus. Late payments can hurt your credit rating, while on-time payments can help your credit.
Amounts owed make up about 30% of most credit scoring models. The amount of debt you have affects your debt-to-income ratio and your credit utilization ratio. Your debt-to-income ratio considers the amount of debt you have in relation to your income. Ideally, your debt-to-income ratio should be no more than 43%, and your credit utilization shouldn’t be more than 30%. If you have a lot of debt, it can bring up both ratios.
Length of Credit History
The length of time you have had your credit accounts is another factor affecting your credit ratings, weighing in at about 15% of your total score. Generally, the older your credit accounts, the better it may look to lenders/creditors. This is because it may show them that you have long-held experience handling credit vs. someone who may be new with credit. As with newer accounts, there may not be any patterns, good or bad, to analyze. Although you may not have control over it, it will be helpful to know about as you try and build your credit history and scores.
New Credit Inquiries
New credit inquiries will impact about 10% of your credit score. Hard credit inquiries may bring down your credit score by a few points, and having multiple hard credit inquiries within a short period of time can harm your credit. Additionally, multiple new credit inquiries may look bad to potential lenders or creditors.
Diversity of Credit Accounts
Having a diverse credit mix is another important factor that impacts your credit scores, usually weighing about 10%. A diverse score means having several kinds of credit accounts rather than just a single type.
Adding to your credit mix means being strategic when applying for credit rather than simply seeking out credit to add to your history. A diverse credit portfolio shows lenders you have experience with different borrowing options, which can help your credit rating.
Things That Do Not Impact Credit Scores
While the variables from above do impact credit; it may also be helpful to understand the different factors that do not have an impact on your credit score;some of these factors you should know about are:
- How Old You Are — Your age will not be factored into calculating credit scores. However, chances are that the older you are, the more diversity and higher credit limits you may have, which may help your score.
- The Current Interest Rates on Your Credit Accounts — The current rates on your credit accounts, whether high or low, will not impact your scores. Your credit scores will, however, impact your interest rates.
- Your Marital Status — getting married or divorced will also not impact your credit scores.
- Getting Credit Counseling — Those struggling with their money or want a plan for it can look at credit counseling, which will not affect their credit score. However, if you are in pre-bankruptcy credit counseling, chances are this may affect your score.
The Most Popular Scoring Models
One of the first questions you may have about credit ratings is where yours falls into. To figure that out, you must first figure out what credit scoring model you are looking at. Most lenders or creditors use the VantageScore and FICO Score, the two most popular credit scoring models.
Here are the credit score ranges for these models:
The Credit Ranges for a FICO Score:
- 850-800 is considered excellent.
- 799-740 is considered great.
- 739-670 is considered good.
- 669-580 is considered fair.
- 579-300 is considered poor.
The Credit Ranges for a VantageScore:
- 850-781 is considered excellent.
- 780-661 is considered good.
- 660-601 is considered fair.
- 600-500 is considered poor.
- 499-300 is considered very poor.
And so, as you can see, when trying to understand your credit scores, it is important to know which model you are looking at. The credit rating agencies (Experian, Equifax, and TransUnion) all use both of these models and may use many others for credit score calculations of your score.
What Is Credit History and Your Credit Report?
Your credit history encompasses all your financial activity that is recorded with the major credit reporting agencies. For example, your first credit account, any missed or on-time payments, bankruptcies, cosigning, or any other financial activity in that realm will make up your credit history.
You will have a credit report with each credit rating agency, and those credit reports will have all your credit history on there, along with your score.
Experts recommend checking your official credit reports a few times a year, as mistakes can happen, and credit reports are often the first place that you can spot signs of identity theft. The good news is that every consumer can get a free copy of their annual report from each credit bureau.
Why Is Having Good Credit Important and Why Can a Poor Credit Rating Hurt?
Having a good credit score is important because it impacts several aspects of your finances; here are some things that may be affected by your credit scores:
- The Interest Rate When You Borrow Funds — Interest rates can rise as a credit score gets lower and go down as a credit score gets higher. This is because the lower a credit score, the higher the credit risk a person is usually considered.
- The Loan or Credit Amount You Could Get — The amount you could get with installment loans or credit limits will be impacted by your credit score. Usually, borrowers with low credit will only have access to bad credit loans which can mean lower amounts and higher interest rates.
- Credit Can Impact Where You Live — Credit scores can affect more than just your finances. Your credit score can influence things like where you can rent, as credit checks are standard with most rental applications. If you are looking to buy a home, then having good credit will be essential, especially if you want to get a deal on a mortgage.
- Credit May Impact Your Job Prospects — In some states, employers are allowed to run credit checks on their interviews; in some cases, having a bad credit score can mean getting looked over for a job over another candidate who may have the same qualifications and background as you but a higher credit score.
How To Work On Improving Your Credit Scores
According to Experian, the average credit score in 2022 was 714. And it may be discouraging if your score does not align with that average or you don’t have the highest credit score. However, the good news is that there are some simple ways you can improve all three of your credit scores.
Make Your Monthly Bill Payments on Time
One of the most impactful ways you can go about improving a low credit rating is to make your credit account payments on time. Your payment history is essential with most financial institutions/ lenders. No matter where you borrow a loan or credit card from, chances are that your lender may report a borrower’s payment history to at least one of the major credit bureaus. By making on-time payments, you can help your credit score, while missing payments can really hurt it.
Keep Your Paid-off Accounts Open
This is especially important with lenders such as credit card companies or other revolving accounts because they impact both aspects of your credit utilization ratio. One of the easiest ways you can help your credit is to keep your credit accounts open after paying them off. Additionally, asking for credit limit increases from credit card companies orother lenders can be an easy way to gain new credit without having to go through a brand-new application process. But of course, be mindful if you aren’t the best with your spending habits.
Be Aware of Good and Bad Debt
One thing you may be trying to do when working to improve your credit score is to diversify your credit report. However, you should be aware that there is “bad” and “good” debt, before taking on a new credit account. Bad debt is usually considered credit cards or some loans that people borrow to just spend money. While good debt may be something that helps you gain equity, such as a mortgage or a student loan that helps you gain an education.
Become an Authorized User on a Trusted Person’s Account
It can be tough to start building your credit report if you don’t have any credit or open financial accounts. One way to build credit without taking out a credit account on your own is to become an authorized user on someone else’s. That way, anytime they make payments on their accounts and the lender reports those payments to the credit bureaus, that history will also be automatically reported on your credit report. However, it is important to only sign up on accounts for people you know make their payments on time, as negative actions such as a missed payment will hurt your score as well.
Have Your Alternative Payments Reported
There are payments that most people make every month that aren’t reported to the credit bureaus—bills like rent, utilities, and phone. However, with the right service, you may be able to get those payments reported! On-time payments can really help a low credit score.
Pay Off Debt
Paying off debt can help both your credit utilization and debt-to-income ratio, which can help your credit scores! And so, try and pay off as much debt as possible; of course, you want to ensure you keep your budget in mind. There are all kinds of debt repayment strategies, some are a little more aggressive than others, but any plan is better than nothing at all.
Correcting Your Credit Reports
If there are any credit reporting errors on your reports, it is important to correct them right away. In some cases, doing so may help your credit score improve immediately. You can access your official credit report via the major credit reporting agencies, or you can request a soft credit pull via most online bank or credit card accounts
What Is the Average Credit Score in the U.S.? | Experian
What is a Credit Utilization Rate? | Experian
Debt-to-Income (DTI) Ratio: What’s Good and How To Calculate It | Investopedia