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Introduction
Most of us are familiar with credit scores – seemingly random number that can dictate so much of how we will be managing our money. This is probably some sort of obscure science or secret language that lenders, landlords and even employers use in their decision making process about us. But what is a credit score, and how does it operate in the real sense? Today this article will provide a breakdown of this enigmatic concept they call credit scores and help shed light on a majorly overlooked component of an individual’s financial planning.
What is a Credit Score?
A credit score is therefore a numerical value that gives a credit worthiness on someone with credit. It is the detailed record of a person’s credit history, credit conduct in the past and credit commitments currently. Credit scores are determined by identified credit reporting bureaus, including FICO and Vantage Score, with numbers relied on the report of the borrower.
The credit score is intended to help any creditor, landlord or employer to instantly determine the level of risk they are exposed to when they offer credit, lease property or offer a job respectively. Credit points scale: Higher the score corresponds to a lower risk and lower score corresponds to a higher risk.
Introduction of Credit Scores
They are an important aspect of the contemporary world of finance. For instance in United States, a good credit score will help one secure an offer for a mortgage, cars loan or even a job. Paying for a house or even an apartment, acquiring utility services, and even phone and internet services may also be determined by a person credit score.
This is because credit scores form a standardized and credible source of assessing credit worthiness of an individual irrespective of their color, sexual reproduction, or income status. They are useful for lenders and decision makers to mitigate the problem of bias and subjectivity that must often be present in persons making decisions based on hearsay and casual experience.
The Credit Scoring Models
In this current world there are many credit scoring models but the most popular one is the FICO. The FICO score is calculated using the following five factors:
1. 498/35 = Not less than 17 Payment history
2. Debt (with three sub factors each contributing 30% of the total score)
3. This is given by the duration of the credit history (15% of the score).
4. Credit mix (10% of the score)
5. Number of new credit inquiries (It contributes 10% in credit score)
The VantageScore model was designed to offer more standardize credit scoring and be more clear on credit scoring. It employs a somewhat different formula but yields somewhat the same numerical value. Both models give scores ranging from 300 to 850 where the credit is healthier if the score is higher.
How Does Credit Scores Take Shape?
According to firms that deal in credit scores, scores are determined by information that appears in an individual’s credit report. Credit reports are documents that summarize a person’s accounts, payment and other aspects of the credit associated with that individual. Thus, to guarantee the correctness of credit scores, credit agencies use credit reference bureaus, such as Experian, Equifax, or TransUnion.
The models employed by FICO and VantageScore select data from the report, then allocate the numerical values in accordance with specific factors. For instance, a member has a longer credit history, they have paid all their bills on or before the due date, and they use less than 30% of their credit limit all will push up the credit score.
They are also dynamic there is no fixed point where your score will remain stuck unless of course you get into the same trouble over and over again. They can vary within a short time depending on what updates an individual gets in their credit reports. This can occur if a person applies for credit at a new credit store, pays off a credit account or fails to make a payment. The most important step to follow when you want to protect yourself from having a low credit score is by using your credit rating and credit balance frequently, analyze your rating, and make sure you pay all your balances on time.
The Impact of Credit Scores
As have mentioned before, credit scores are essential tools in our lives financially. They may influence our chances of getting credit , finding a job or even housing. The influence of credit scores seems to permeate through almost all spheres in this life.
For instance, a creditworthy individual has better chances of being given an affordable mortgage or auto loan or being charged a low interest rate that is less expensive in the long run. On the flip side, a person with a poor credit rating is likely to be barred from accessing any credit at all or get credit at a considerably higher rate.
Employment is also a factor that depends on credit scores. Of course some organizations have credit check during the hiring, thinking that the scores or report on credit means that the individual is a credible and responsible one. This may be a practice that is frowned at by most, but it is legal in most states, and may have bearing on a person when it comes to employment opportunities.
There are by now, people with credit scores who lack jobs or loans, but still have no option other than to face the reality of not being hired, denied loans, unable to rent an apartment or gain access to essential utilities. Housing companies and providers of utility bills may be interested in credit scores as a tool to determine whether or not a person would be able to pay their bills in time and avoid resultant.
Credit scores as the dark side
Although credit scores can be very helpful to the lenders and employers they can also be very stressful for the users. Most people regard credit scores as obscure and unexplainable personal attributes, and they dare not tweak them to their advantage.
This cycle puts people under a lot of financial stress, and to try to boost their credit rating, they engage in costly activities such as borrowing or paying their bills past due. It can also extend to identity theft or credit fraud, where a criminal uses other people’s information to open credit accounts.
However, the application of credit scores in employment and housing gives a form of financial discrimination, whereby people in a given class (low income earners or those with bad credit scores) cannot work or rent houses, depending on the scores.
Ways You Can Change Your Credit Score
Even though credit scores are stressful, there are things you can do to ensure you & your credit rating is on the right track.
The first of the ten critical guidelines will be to always read your credit report thoroughly. You are allowed three free creditreports each year from each of the three major credit reporting agencies and you should check them often for errors or fraudulent information.
In the third position, be timely in your bill payments, at all times. One of the convenient features of this system is that payment history accounts for the largest part of credit scoring, hence it would be beneficial to keep a good payment record.
Do not use most of your credit limits. This means that you should ensure that the proportion of your spending does not exceed 30 percent of the total credit limit on all of your credit cards. Maxing out credit cards shows that you are overburdened and is likely to put you into a higher risk category.
Do not apply for new credit accounts and obtain new credit cards within a short period of time. Every time you request credit, a hard credit check is reported and it’s bad for your scores. It is advisable to open new account only when necessary.
Last but not least, one should keep some balance in credit types. A credit card, car loan, and a mortgage can all be beneficial to your credit score since they show that you have multiple credit accounts, which means you can manage the different types of credit.
Conclusion
Credit scores are an integral and a very sensitive part of our lives. Though they may appear complicated and sometimes intimidating, it is valuable to learn how they function, and maybe, take measures to keep that score high significantly influences our financial success. Overall, credit is full of significant opportunities that can help people improve their financial situation in the future if they take it into their hands and start repairing their credit today.
