Takeaways:
- Your credit score is a public report card of your financial habits, as provided by credit bureaus.
- The higher the score, the better your financial habits. After achieving a threshold (~800+), you are eligible for the best credit products (e.g., lowest mortgage rates, best credit cards, etc.)
- There must be enough credit history to have a credit score. This means you need to establish credit to build credit.
- After establishing credit, certain habits are critical, including paying off statement balance on-time, keeping credit utilization low, and monitoring credit reports.
What is credit?
Before jumping into credit scores, let’s define credit first. Credit is the ability to pay for something later or over-time while receiving the benefits today. There are a couple of types of credit available to a consumer.
- Revolving credit. Think credit cards for this category. This type of credit allows the consumer to borrow up to a maximum limit. In exchange for the flexible borrowing, the consumer is expected to make a minimum payment each month and incurs interest expenses and fees on the difference between the monthly payment amount and the full statement amount.
- Service credit. An example of service credit is utilities. This type of credit is extended in some service or benefit where the consumer pays for the consumption later.
- Installment credit. These loans have a predetermined repayment schedule, such as mortgages, auto loans, and student loans.
What is a credit score?
Your credit score is a measurement of how financially trustworthy you are as determined by the credit bureaus. Credit scores range from 300 to 850.
From an outsider’s perspective, high scores suggest that you manage finances well, repay debt consistently, and not overborrow. On the other hand, low scores indicate that you are likely a risky borrower per standardized definitions.
Why does a credit score matter?
People who extend credit look at your credit score to determine their risk in lending you money. Risks include whether you will make scheduled payments on time, whether you will repay the money borrowed, etc.
Some examples of when credit scores matter:
- Landlords pulled credit scores for potential tenants before renting a place
- Banks and lenders review credit scores before extending a personal or business loan
- Mortgage lenders also check credit scores before approving a mortgage
What is a good score?
A credit score above 800 is exceptional. That’s the top tier for goal-setting. Here’s a simple breakdown of the typical FICO scores is below.
- 300 – 579: Poor. Credit may not be approved at all.
- 580 – 669: Fair. Considered subprime (i.e., risky).
- 670 – 739: Good. Low likelihood of being seriously delinquent.
- 740 – 799: Very good. Better than average rates available.
- 800 – 850: Excellent. Best rates from lenders available.
As a point of reference, the latest average FICO score is 706.
There are also alternative credit score models (e.g., VantageScore). The concept is the same.
How to build credit?
To build credit, you have to establish a credit history. There are several ways to establish credit if you don’t have one today – talk to your bank and financial advisor to discuss options in detail.
Once you establish credit, building credit takes discipline and time. There are some good financial and credit habits to keep in mind. These habits include:
- Make payments on time and pay off the statement amount
- Utilize your credit but maintain credit utilization below approximately 25% of the maximum limit
- Avoid applying for multiple credit accounts and, therefore, doing multiple hard credit score pulls in a short period
Certain circumstances may push you to not pay off the full credit statement on time, and that’s ok. However, it’s best to spend the money you have to avoid outstanding credit amounts to balloon.
Credit report hygiene
As you are on your journey to build and maintain credit, it’s essential to monitor your credit report for errors and fraudulent activities. You can request annual credit reports from credit bureaus to review them. If you find any errors, you can dispute them and request corrections.
Disclaimer: The contents of this website is an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.