You may have heard the term ‘credit score’ thrown around but not really know what it is and how it affects you. It’s actually quite important: your credit score matters a lot. Read on to learn more about credit scores and how they affect you IRL.
What is a credit score?
Your credit score is a number that reflects your creditworthiness. “Creditworthiness” refers to how worthy you are of credit — in other words, are you a responsible borrower and do you make your payments on time.
Credit scores can be from 300-850 — the higher the number, the better your credit score. You may think that your credit score is just a number but it actually has some real-world implications you should know about. Here’s why your credit score matters:
1. It affects your interest rates
If you’re looking for a mortgage or shopping around for a car loan, there’s one thing that can affect the total cost of the loan — the interest rate on your loan. If you have high interest rates, it could cost you thousands of dollars over the life of the loan.
If you have a good credit score you can get approved for better rates. Better rates mean saving more money!
2. Employers may check your credit
Did you know that some employers actually check your credit as part of the hiring process? Yep, it’s true. Employers don’t get to see your exact score but a version of your credit report. The information in your credit report is what determines your credit score so it’s all interrelated. To check your credit, you do have to give permission for your employer to do so.
While some states are moving away from this as some say it’s discriminatory and unethical, there are places that may check your credit.
Imagine getting far into the hiring process and then being denied your dream job because your credit isn’t good enough.
3. Getting approved for an apartment
Your credit score can help you rent your first apartment, if you pass the eligibility requirements. I remember when I applied for my first apartment I was nervous about my credit as I only had student loans. I never had a credit card or any other type of loan.
Luckily, because of my positive repayment history with my student loans and my on-time payments, I had a credit score of 720. The threshold for the apartment I wanted and later moved into was 700!
Landlords check your credit to determine if you’re a good fit for one of their rentals. Having a bad credit score can make it tough to find a place to live.
How to improve your credit
So what if your credit score isn’t that great? First of all, don’t freak out. But it’s key to understand why your credit score may be bad. To help you understand, here are the five things that comprise your FICO credit score (the most popular credit score).
Payment history — 35%
Credit utilization — 30%
Length of credit history — 15%
New credit — 10%
Credit mix — 10%
If you have a history of missed payments or consistently rack up your balance, your credit score could take a hit. If you have a limited credit history and one type of loan like a student loan, your score may be low or there may not be enough data yet to make a score.
Another reason your credit score may be damaged is if you applied for too many loans. If you applied for various lines of credit within a few months, it could send the message that you’re a risky borrower to the lender.
To improve your credit, you want to only borrow what you need and keep the balances low. You also want to make sure your payments are on-time, too. When it comes to your credit score, your ability to make payments on time is the largest contributing factor.
Don’t close old accounts and don’t open a ton of new credit accounts either! Taking these steps consistently over a period of time may help improve your credit score.
Your credit score may seem like an arbitrary number that doesn’t really matter. On the contrary, my friend! Those three digits can make or break you and affect big life situations like where you live or work or how much interest you’ll pay. Understanding this and taking the appropriate steps to keep your credit in good standing can make all the difference.
Melanie Lockert is a personal finance expert, the blogger behind DearDebt.com and author of the book “Dear Debt: A story about breaking up with debt.” Melanie paid off $81,000 of debt and is now on a mission to help others do the same.
Feature Illustration: Laura Caseley For The Money Manual