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What is a Credit Score? A Simple Way to Understand Credit

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Building Credit Tips | Personal Finance Tips

Understanding How to Improve Your Credit?

Credit is a confusing topic, but it doesn’t have to be. 

To simplify the concept, the HIGHER your credit score is the LESS you will pay in fees whether you are buying a house, a car, taking personal loans, business loans, or getting credit cards. 

The LOWER your credit score is, the MORE you will pay for the above items. 

So the goal is to have your credit score as HIGH as possible and avoid things that could make your credit score LOW. 

Ok, so, what the heck is a credit score? 

A credit score is a number that is assigned to you based on your financial history and patterns that give banks, lenders, credit cards a snapshot into what they perceive as the risk of doing business with you. 

The HIGHER your score, in their view, the LOWER your risk to them. 

The LOWER your score, in their view, the HIGHER your risk to them. 

Just think of them as a skeptical lender who would think twice or even thrice if you have a bad history with the finances.

Who creates the credit score, to begin with? 

There are 3 credit reporting agencies that corner the market in this area, which are Transunion, Experian, and Equifax? 

Think of them like the referees in a sporting event. Their job is to not be for you to have good credit or bad credit but to report the status of your financial decisions. 

What is considered a good score? 

The range of credit scores vary and each lender is different,  but let’s work with some simple guidelines:

  • 760 – 850 = Excellent 
  • 700 – 749 = Good
  • 650 – 699 = Fair 
  • 600 – 649 = Poor
  • Bellow 599 = Bad 

A great FREE way to see your credit score and get your report is with Credit Karma. It does not hurt your credit.

THIS IS COMPLICATED; HOW DO I UNDERSTAND MY SCORE?

Your credit score is made up of a few main things. There are many other factors, but the ones mentioned below are some of the significant factors worth mentioning. 

These categories are also not created equal so let me first give you the breakdown of how each item is weighted: 

  • Payment history: 35% 
  • Amount of debt: 30%
  • Length of Credit History: 15%
  • Types of Credit (Credit Mix): 10%
  • History searching for credit: 10%
  • Ok, now let’s dig into what they mean. 

Your payment history: 

This just means that when your bills are due you and you pay them, this gets reported to all three credit agencies. They do not report you late for 30 days after you are supposed to pay that bill. 

Pro tip: There is no need to panic if you miss a day or two. You just do not want to miss more than 30 days without communicating with that particular vendor, or it will negatively impact your credit. 

The length of time of your credit history: 

In the world of “credit history”, 5 years is a VERY short period of time. A common mistake is that people get a new credit card and CLOSE the old one out and don’t take advantage of the length of time the account is open. 

Pro Tip: ONLY close ones that have an irrational annual fee, otherwise keep the cards open, and that time will HELP you improve your scores.

The amount of debt you owe:

Debt is important to note. They do not want to see that you have NO debt, but they do not want to see you SMOTHERED in debt either. 

Pro Tip: If you have debt and can’t pay it off every single month, try to keep the threshold under 50% for each that is open. It starts to reflect negatively on your report once it is over 50% threshold. 

The types of credit you have open OR don’t have open: 

This is what is called your “Credit Mix” and it makes up 10% of your overall score. There are 3 kinds of credit, and they are as follows: 

  1. Installment Credit
    1. These are fixed loans that you pay at regular intervals. Examples of this would be a mortgage, car loans, student loans, and personal loans.
  2. Revolving Credit
    1. It allows you to pay for things now, and then you can make the payment at the end of a billing cycle. Examples would be credit cards, home equity lines of credit, and department store cards.
  3. Open Credit 
    1. This type of credit is when you pay for services after you have already used them. Examples of this would be electricity, gas, etc. 

Pro Tip: A good credit mix is as follows

  • 1 installment type of credit 
  • 5 revolving credit cards (3 traditional credit cards and 2 department store credit cards) 
  • at least 2 open credit types 

This is a good credit mix, BUT DO NOT DO ANY OF THIS UNLESS YOU WILL PAY OFF WHAT YOU CHARGE EVERY MONTH. 

It is better to have a LOWER credit Score than to dig yourself out of a mountain of debt. Credit can be good IF it is used correctly. 

Your history of applying for credit within short periods of time:   

No vendors like to see you applying for anything too close together. Credit cards do not like it,  nor do the banks. 

Pro Tip: So, if you have a plan to apply strategically for credit, space these things out. Apply for 1 every couple of months maximum.

Credit is only complicated because many of us were not taught this in school. It is more simple than you think once you understand the basics. 

You do not have to be an expert at credit, but it is important to study the basics of how it works so that you can avoid and the negative impact it could have, yet take advantage of the positive side of using credit. 

Think of credit as dollars in your pocket. The higher your score is the less you pay for the same items. Over time, this has a compounding effect. 


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