Credit scores are one of the most important factors that can affect your financial life. Because of that, it’s crucial that you understand them thoroughly. We’ve put together this guide to give you information on credit scores and how they impact you.
What is a credit score?
A credit score is a value that’s meant to show how trustworthy you are to lenders. It’s calculated by compiling your past financial history and turning that into a number from 300-850. The higher the number, the more responsible you’ll seem to lenders.
Who calculates the score?
While there are technically many different types of credit scoring model, the vast majority of lenders use the one made by FICO, or Fair Isaac Corporation. This score was introduced in 1989 in order to create a universal credit scoring method, and it succeeded. Now, according to the company, it’s used by 90% of vendors to verify their customers.
FICO itself doesn’t calculate your score; instead, it sends the formula to the three major credit bureaus, These three bureaus are Equifax, Experian, and TransUnion, and they are the ones who collect your data from banks, loan companies, and landlords to compile it into credit reports and, with the help of FICO’s model, turn it into a score. These three credit agencies also jointly created VantageScore, another credit decisioning model and a competitor to FICO. The FICO score is still the most widely used, but it’s important to know all of your options.
What is a good/bad credit score?
Exceptional: 800 to 850
Very Good: 740 to 799
Good: 670 to 739
Fair: 580 to 669
Poor: 300 to 579
What happens if we have a good/bad credit score?
Good or higher credit (at least 670) can get you lower insurance rates, lower credit card interest, utility services like electricity and Internet, and even make you look better on job applications. It’s much easier to get loans if you have high credit, and the interest will be lower too. Buying a home or a car can also be dependent on credit, since both of those depend on loans– mortgages and auto loans, and lenders won’t want to give you loans if they think you’re a credit risk.
What reduces a credit score?
The FICO score is made up of payment history (35%), credit utilization (30%), credit history length (15%), credit mix (10%), and new credit (10%). While there are many versions of the FICO score, these five factors influence all of them.
As you can see from the percentages, payment history is the most influential factor that can reduce your score. If you miss payments, even just a couple times, that can heavily impact your score. Credit utilization– the ratio of credit you’re using to credit available– also is very important in your credit score. If you’re using more than 30% of your available credit, that will look bad to creditors, because it suggests that you’re dependent on it. Credit history length is just how long you’ve been holding accounts, and this is often difficult to change. It is a large burden to young people, who’ve just started gaining history, and immigrants who don’t have history in the USA. Credit mix is the variety of accounts that you have. If you only use one type of credit product, or you don’t manage the ones you have well, then that’s a minus on your credit score. Finally, having too much new credit– that is, opening too many accounts too quickly, or applying for credit too often– can hurt your credit.
How can we improve our credit score?
The most important thing you can do is pay your bills on time. That shows lenders that you’re trustworthy and able to manage your debts. If you do miss a payment, make sure to pay it as soon as possible, because that can stave off a big hit to your credit score, though it will still go down. It can also be useful to pay off the debts that you have, if you’re using too much of your available credit. Try not to apply for too much new credit, either, because it may look like you are in too much debt to pay without the help of credit. Also, try to improve your credit mix. The best way to do this is to make sure you have at least one of each type of credit– revolving credit and installment credit. Installment credit is any kind of loan where you have borrowed money and you’re paying it back on a monthly basis. This includes student loans, mortgages, and personal loans. Revolving credit is any agreement that permits you to repeatedly borrow money which you repay monthly, although it typically just refers to credit cards. If you’re unable to get a credit card, you can apply for a secured card, which you need less credit for. Another way to improve your credit score is to ask someone with a good history if you can be added as an authorized user on their credit card.
Lastly, make sure you know that reports can have errors, too. If you think something is incorrect on your report, you can dispute it.
How do bills affect our credit score?
All bills have the potential to affect your credit score, but only some can affect it positively. For example, providers of rent and utility bills aren’t going to report your payments to credit bureaus. They aren’t considered credit accounts; instead just paying for a service, so they rarely ever show up on credit reports. However, if you don’t make your utility or rent payments on time, your service provider may report your account to a collection agency, which will send the information about your delinquent bill to the three major credit bureaus, which will hurt your credit score. In summary, rent and utilities (in most cases) won’t help your credit score; only hurt it. There are some workarounds to this, though– keep reading to find those out.
The bills that help to build credit are the ones belonging to the categories installment loan and revolving credit. Most loans fall under the installment category: you’ve borrowed an amount of money to pay for something like school, a house, or a car, and you pay it back monthly in installments. With revolving credit, you repeatedly borrow money and keep paying it monthly. Credit cards fall under this category. If you pay these on time, that will be reported to the major credit bureaus, and can help boost your score, and if you pay them late, that will also be reported, and can harm your score.
In the last couple of years, Buy Now Pay Later apps, that enable consumers to pay in 4 installments, typically for e-commerce or other big ticket purchases, have gained popularity. These products are also structured as installment loans or revolving credit line, and can help build credit if your payments are reported to Credit Bureaus. For e-commerce purchases, apps like Klarna, Affirm, Sezzle, QuadPay, and AfterPay, have become household names today. However, all of the aforementioned players may not be reporting your payments to Credit Bureaus. For utility bills and rent, apps like Neon For Life, to pay bills in installments, are quickly gaining popularity. Neon For Life is a bill pay app that helps you pay rent and utility bills on-time and reports your repayments to Credit Bureaus, helping you build credit.
Are there any ways to have utility bills and rent count towards your credit score?
You can try using a credit reporting service. Some of them will let you get credit for utility bills and rent. An example of a service like this is Experian Boost, which checks your bank records to find evidence of on-time payments, which can help you get a “boost” on your score. However, that increase will only show up if a lender uses Experian to check your credit score. Your credit scores with TransUnion and Equifax will remain unchanged. There are also other services like Esusu, which your landlord will need to partner with to enable reporting your rent payments to these credit bureaus. The downside is that you will need to pay an extra monthly fee and you depend on your landlord to enable this feature.
Another thing you can try is charging your bills to your credit card or using an app to pay bills in installments, such as Neon For Life. As long as you use one of these products responsibly and make repayments on time every month, your payments will be reported to the credit bureaus, which in turn can help you build credit. However, there can be extra fees associated with paying certain utility bills or rent using a credit card. And credit cards may not be accepted by your landlord or property managers, and or there may be high convenience fees associated with card payments.Using an app such as Neon For Life, to split bills in 4, will allow you to reduce credit card convenience fees and avoid interest charges. As an added bonus, when you use Neon For Life to pay utility bills or rent bills, all your bills are paid on time, and this helps you avoid late fees for bill payments.