The term credit score pops up regularly in newspapers, blogs, and daily life. Everyone knows it’s a number with the capacity to make or break one’s financial abilities, but what does it really mean? Here’s everything you need to know about credit scores and building credit.
What is a Credit Score?
A credit score is used by lenders to determine the risk of a borrower. When we talk about risk, it essentially means the likelihood that the borrower will repay a loan. Credit scores range from 300-850 and there are several scoring systems used by companies. The most commonly used system is FICO, although many lenders use VantageScore.
One’s credit score is based essentially on their credit history, which is used to assess whether they are a risky investment. In other words, it tracks one’s accounts, debts, loans, and repayment history over the course of when they’ve owned a credit card. It’s typically calculated based on one’s payment history, the amount they owe, how long they’ve owned a credit card and any new credit accounts opened.
The higher the credit score the less risky the borrower, whereas someone with a lower credit score might struggle to find a company willing to take them on as a customer. Individuals with lower credit scores may have higher interest rates in comparison to someone with a credit score above 700, which is considered a benchmark for many companies.
All credit scores have different thresholds that determine whether you’re a reliable consumer:
– Excellent: 800 to 850
– Very Good: 740 to 799
– Good: 670 to 739
– Fair: 580 to 669
– Poor: 300 to 579
Anyone within the Good to Excellent range is typically considered reliable. So, the more reliable you are, the more benefits you might get. As you build credit and maintain a good credit score you might even gain access to a range of cards with cashback and other rewards.
Why Does it Matter?
Generally, a credit score is what determines your ability to buy a house, rent an apartment, purchase a car, and buy any other major living purchases. It also affects your ability to obtain a mortgage, a loan, and more importantly, low-interest rates, which essentially helps you save money in the long term. If a company considers you a subprime borrower, a term used for someone who is a high credit risk, you might have to pay higher interest rates on loans and mortgages. Subprime borrowers typically include those with a credit score below 670 and usually have something bad in their credit reports such as foreclosure, bankruptcy, repossession, or multiple missed payments. However, individuals with a short credit history could also fall into this category. If you fall into the latter, it’s nothing to worry about. Slowly, you’ll build up your score.
To practice good credit habits, make sure to manage your payments and pay off balances on time. Many credit card companies offer auto payment options that link to your bank account typically through the company’s mobile app. This will automatically pay your fees on a specified date and is a great way to stay on top of payments. If that’s not an option, make sure to set a reminder on your calendar.
What is a Credit Limit?
A credit limit is essentially how much money you can borrow from a financial institution or lenders. It’s a defined amount that you’ll need to repay typically monthly by a certain date. Your credit limit is based on your credit score, credit history, risk, income, and other key factors. Credit lines are important since they dictate how much you can spend a month with your credit card.
While credit card companies typically give you leeway, be conscious. Do not use 100% of your credit line because this can negatively affect your score. Experts suggest that you stick to using less than 30% of your credit limit to keep a good, very good, or excellent score. The more you use, the riskier you appear to the credit card company, even if you have enough funds in your bank account to repay the loan.
For example, if your credit line is $1,000 a month, stick to using $300 or less. The less you use, the less likely it is to affect your score. It might be smart to get additional credit cards over time as you build a credit history. This is a great way to space out your credit and ensure that you stay within the accepted range. However, make sure to space out when you open accounts. If you apply for or open multiple credit cards within a small time frame, a credit company might see you as a red flag and question whether you’re worth the risk.
You can always ask a credit card company to increase your credit limit. This might drop your score by a few points because the company will need to assess whether you meet their standards. However, the drop is typically minuscule and only temporary.
How Do I Build Credit?
If you’re a student the best way to build credit is by tacking onto a parent or family member’s credit plan. This is a great way to build credit and will likely extend your credit history. In most cases, you’ll get a credit card with your name that you can use for purchases, however, the designated cardholder will make the monthly payments. Keep in mind that you’ll want to join someone with a good credit standing since you’ll likely inherit their credit score.
However, for some people, this might not be an option. In that case, there are tons of credit cards out there that specifically target students like these Discover cards. The Discover it Student Cash Back card, in particular, offers 5% cashback on everyday purchases like groceries and gives you a $20 credit each year you get a GPA above a 3.0. If you apply for a student credit card, try putting just a few expenses on it a month to slowly build credit. This will ensure that you maintain good, reliable standing with the company and is a great segway for anyone starting from the beginning.
Ultimately, the better your credit score, the better the perks. As you build credit and maintain a good credit score, you can gain access to tons of rewards cards with amazing benefits. So get started on building your credit today!