What is a credit rating and why does it matter?
You probably already know that a credit rating is important, but do you know who needs to see your score and how it’s calculated?
A credit rating is also commonly called a “credit score” and is a number that acts as a report card on how risky it is to lend you money. For individuals this number is usually between 300 and 900, depending on the bureau that reports the score — as each one has a slightly different rating scale.
What’s certain is that every lender will be interested in your score. From car dealerships to credit card companies, lenders want to know your credit risk before they decide how much money to lend you — as well as what interest rate to charge. Those lenders are usually willing to lend more money (and offer you lower interest rates) when you have a higher credit rating.
Who tracks my credit rating?
Both of these companies collect and compile all sorts of information about you from various sources including the credit card company, credit union or bank, cell phone providers and many others.
What are they looking for? In particular, they want to know how you’ve used your current credit, which will tell them if you a risky borrower.
Based on this information, the credit bureaus will determine your score and then allow other companies to look at your credit rating. This will factor into any other lender’s decision on whether or not they allow you to borrow money from them.
How is my credit rating calculated?
Your credit rating takes into account virtually every payment or bill that’s on record. Did you pay off your credit card bills and retail department store account payments this month? Did you make your student loan payment on time? A credit report will know.
Here’s the rough breakdown on how credit bureaus come up with your credit rating:
Payment history (35% of your score): Did you make your past payments on time? Have you missed any payments? If so, how recently and how often have you missed those payments?
Used credit vs. available credit (30% of your score): How much credit do you have available compared to the amount you’ve used on your credit cards or lines of credit?
Credit history (15% of your score): Did you just begin borrowing money or do you have a solid track record of using credit responsibly over many years?
Public records (10% of your score): Have you ever had collection issues or a prior history of bankruptcy? This may have a significant negative impact on your score.
Inquiries (10% of your score): Whenever your credit file is accessed, that is considered an inquiry. Inquiries that are related to trying to access credit, such as applying for a new loan or credit card, may impact your credit score. That said, it will likely take a number of these types of inquiries around the same time to have any significant impact.
Your three-digit rating, aka your credit score, may not be a number that you focus on daily, but nonetheless, it can be highly consequential in your life.
For example, if you have an extremely low credit rating you might not be able to get a car loan or mortgage to purchase a house. If your credit rating is moderate you may still be able to access a loan, but at a much higher rate than if you had a very good credit rating.
Not all credit bureaus have the same scoring system
Credit scores generally range from 300 to 900, however, the ranges aren’t all the same for each credit bureau.
For example, According to Equifax, “Credit scores from 580 to 669 are generally considered fair; 700 to 749 is considered good; and 750 and up is considered excellent.” While for TransUnion, the credit scores differ slightly. For example, scores above 780 for that credit bureau are considered excellent.
It is also important to note that different lenders may have different views on what score is good enough.
Also remember that on a large purchase like a house, a few percentage points difference in your interest rate can cost you many thousands of dollars over the lifetime of the mortgage. With a higher credit rating, you can avoid those costs.
No matter whether you’re just starting to build your credit or if you have an extensive payment history, your credit rating will come into play for life’s major moments. When you’re ready to buy a house, rent an apartment, purchase a car or borrow money for any of life’s requirements, understanding your credit rating and ensuring you have the highest score possible will make you better prepared for that next step.
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