Do we sometimes obsess on credit scores? Yeah, probably. But they are important. Sure, a credit score is just a number, but it’s a representative one of a subject much of the world considers to be extremely important: our credit histories.
Credit scores exist because they offer the reviewer a snapshot of your credit report. If you’ve ever seen a full credit report, you know it’s a fairly complex document that’s rampant with coding. Credit scores enable a reviewer to look at the scores before deciding to dig deeper. An excellent credit score may indicate that no further investigation is necessary. And average score might suggest deeper review, and a poor one could mean a summary denial.
That means that credit scores make life easier for the people and agencies we do business with, but not necessarily for us. But that’s why we need to keep a close eye on our credit scores, so we can fix what’s broken before it becomes a problem.
How Important Is a Credit Score?
We generally tend to think about credit scores when it’s time to borrow money. This can be for a car purchase, a credit card or credit card balance increase, and most of all, for a mortgage. Credit scores matter in the approval process of nearly any type of loan, but they can also affect the interest rate you pay. The best rates are usually reserved for those with the best credit scores. So, generally speaking, the higher your credit scores, the lower your interest rate.
But there are situations apart from borrowing where credit scores are important. Employment is one. Prospective employers routinely pull credit reports on their new hires, often to determine if they’ll hire them at all. Insurance companies will run credit on new customers and that can have an effect on the premiums you’ll pay. Landlords also run credit reports and often, so do utilities.
You may not think that credit scores mean much at the present moment if your situation seems pretty settled. But sooner or later, you’ll need a new loan, a mortgage, a new apartment, a job or an insurance policy, and your credit score will figure in each scenario.
What’s a Good Credit Score?
Credit score parameters have changed some in recent years and it’s not always clear what is a good credit score anymore.
Credit scores are grouped in ranges. Excellent is a score of 800 or above, very good is 720 to 799, good is 650 to 719, fair 600 to 649, and anything below 599 is considered bad. Generally speaking, a credit score of less than 600 will be insufficient in order to obtain a mortgage. Other interested parties who use credit scores will have their own established ranges that they’ll consider either acceptable or not.
As you can see, the higher your score the more opportunities will be open to you, and this is why keeping your score as high as possible is so important. Beyond qualifying you for approval for a loan, a job, an apartment or an insurance policy, excellent credit scores can often mean you’ll pay less for whatever it is you’re buying.
Tips to Improve your Credit Score
If you want to improve your credit score, it’s a good idea to approach your efforts systematically. Here are some tips that can help you improve your credit score:
- Pay your bills on time. Payment history is the most important aspect of your credit score. Late payments are one of the biggest hits to your credit score. If you pay late repeatedly, you are likely to see a rapid decrease in your score.
- Keep your debt balances low. Don’t max out your credit cards. When you are close to your available credit limit, it sends up red flags and can lower your score. Try to keep your balances lower than 50% of your credit limit. It’s even better if you can keep it to 30% of your credit limit.
- Maintain a long credit history. The further back your credit history goes, the better. When you can show that you have a long history of using credit (especially if you use it responsibly), you can boost your score. You might not want to close a paid off credit card that you no longer use if it’s your earliest source of credit. Put a charge on it on occasion to keep it active and then pay it off immediately.
- Have various types of credit. You don’t want all of your credit to be in one category. Mix it up a little. Some different types of credit include credit cards, credit lines, car loans, RRSP loans, and mortgages. The variety of revolving credit and installment credit can help reinforce your credit history, and show that you can handle different credit situations.
- Don’t apply for more credit than you need. The more credit applications you have in your recent history, the more credit hungry you look, and the lower your credit score will be.
- There are also errors and this is not as uncommon as we think. With computerization, a simple keystroke error by an entry person could result in a late payment being recorded where there was none. If you have the evidence that you were never late you can successfully dispute the information and get the lender to change it on your credit report.
Following these steps should help you improve your credit score fast, although “fast” is usually a relative term. It usually takes at least 60 days to see any improvement, and it could take longer (90 to 120 days or more) to see substantial improvement.
You Need to Use Credit to Get a Credit Score
You’re responsible with your finances. You don’t use credit cards, preferring to pay with cash. A debt-free lifestyle means that you are in charge of your finances, and your money is working for you — rather than working for someone else. It seems like you should be rewarded for such behaviours when you apply for a mortgage. Unfortunately, that’s not the way it works. If you are living debt-free, then you may find that your credit score isn’t as good as it could be, and it could mean a higher interest rate on loans you are approved for.
The main thing about a credit score is that it is used to measure your credit worthiness. This means that there needs to be information on how you use credit. If you don’t make use of credit, then there is no data for the score. If you look at the five general factors that determine your credit score, it becomes apparent why debt-free living doesn’t help your score.
Since the most important factor is your payment history, you need to be making payments on something in order to have a good score. The next important factor is your credit utilization — how much of your available credit you are using. If you don’t have any credit accounts at all, your credit utilization will end up being a negative item, dragging down your score.
Other factors include the length of your credit history, the types of credit that you have, as well as new credit applications. It seems unimportant to worry about your credit score, but it could affect more than just the interest rate on a loan that you might get. Landlords, insurance companies and cell phone service providers might all check your credit score, and what they find can have consequences. This is especially true if the insurance company charges you a higher premium because of your credit history (or lack thereof).
So, Do You Have to Go Into Debt for a Good Score?
It may seem backward that you have to get into debt in order to have a good credit score, but the whole system is designed so that you have to use credit. The good news is that there is no reason to live a debt-ridden lifestyle if you want good credit. You do need to use credit to build a good score, but that doesn’t mean that you have to live in a debt cycle.
You can use credit cards to help build a good credit score. If you use your credit carefully, paying off your balance quickly, you can begin to build a history. Additionally, something basic like a car loan can be of use. Try to borrow as little as possible, and pay it back quickly. You will minimize the interest you pay while establishing a credit history.
For now, your credit score is a necessary evil. You can take steps to build your credit without getting into debt, but you need to concede to using a credit card (responsibly!) on occasion.
You’re on Your Way to Improving Your Credit Score
Once you establish good credit habits and follow them consistently, you will be able to improve your credit score, and then maintain this higher score. You’ll get access to better financial products and services, and even save money over time.
Keeping an eye on your credit score
Because of the easy potential for reporting errors, it’s a good idea to monitor your credit scores regularly. It can cost money to do this, but there are ways to get your credit scores online for free. This is always recommended since you’ll need to do it periodically.
Credit scores won’t reveal a specific credit problem, but a significant decline in your score can tip you off that something’s wrong. Credit scores are based on the information contained in your credit report, and a drop in your score—say at least 20 points—is an indication that something’s wrong. When it happens, order a copy of your full credit report (a triple merged, or “tri-merged” is usually sufficient) and find out what the problem is.
The advantage of doing this when your score drops is that you’ll be catching the problem just after it happens, and those are a lot easier to fix than one that’s several years old. The reason that recent is better is that you probably have your payment documentation close at hand, either in a recent bank statement or available with your online banking.
As soon as you discover a problem, fix it immediately. The wheels of the credit reporting system don’t roll as quickly as we’d like and by fixing problems when they happen, you’ll be prepared in advance for applying for a job, a credit card, a mortgage or an insurance policy.