Managing your credit is one of the most important things you should know about. This was one of the concepts I had heard about for ages but didn’t completely understand till I took a personal finance class in sophomore year. It was only then that I realized that almost all the major financial decisions in your life will depend on your credit history/score- the car you buy or lease, the home you rent or buy, the credit card you are approved for, your insurance rates. Your credit score lets a prospective lender (a company which could give you a loan to buy a car or a house or be approved for a credit card) know how well you’ve managed your past and present debts. Basically, they are being asked to lend you money and they want to know how well you have managed your past and present debts and how much of a credit risk you are.
FICO (Fair Isaac Corporation) is a company that developed a credit scoring model used by lenders to judge how creditworthy a person is.
A FICO score is a three-digit number- ranging from 300 to 850-that measures a person’s credit risk. A higher score indicates less risk and a better chance of getting a loan.
To start with, most people’s credit scores are between 500 and 700 points, depending on what you first do to establish credit. But it’s not like you just automatically receive a credit score the day you turn 18. You won’t have a credit score if you’ve never opened a credit account.
You need to be at least 18 years old to apply for credit and start building your score. Then, about 3-6 months after opening your first credit account, you will get a score.
These are the five things that you need to be on top of because these are what FICO uses to calculate your credit score:
- Payment history: This is the single most important factor which affects your credit score is your history of paying credit accounts on time – the number of late payments you have made etc.
- Accounts owed: If you use the majority of your available credit, lenders could view you as higher-risk, though owing money on credit accounts isn’t necessarily bad.
- Length of credit history: The longer your credit history, the more it helps your credit score, since lenders can get a better picture of how much of a risk you are.
- Credit mix: The different types of credit you have, such as credit cards, installment loans, and finance company accounts. While it’s not as important as other credit score factors, having a diverse set of installment and revolving credit accounts can help boost your credit score.
- New credit: your credit score can fall if you open too many credit cards in a short period of time.
Accessing free credit counseling programs can help guide you in ways to increase your score. One of the best ways to build your credit history is to apply for a secured credit card and to pay down your debts by their due date.
FICO has some helpful suggestions about ways that people without a real credit history or bad credit can start building credit:
- Get a secured credit card. Even a person without much credit history should be able to get approved for secured credit card. This card requires you to pay a refundable security deposit to reduce the risk to lenders.
- Report your rent and other service providers to credit bureaus. This will help build your credit history. Usually, landlords and utility companies don’t report to the credit bureaus, but you can request that they do so.
- You can become an authorized user on a family member’s credit card. This was you can make purchases with their credit card and build your own credit.
The main credit bureaus are Equifax, Experian and TransUnion. They put together and then sell credit reports on individuals, which they then sell to prospective lenders and others. These credit reports are then used to help calculate your credit score.
Learning to keep up with your credit score can be your first step towards getting your finances under your control. Hopefully this helps.
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