Have you ever thought that a credit score can play a major role in a lender’s decision to offer a loan? Many people don’t know about it until they try to buy a new house, need a loan for starting a business, or need a loan for other major payments. Each person has his/her own credit score.
If you are a married person, then you will have your own credit score, and your spouse will have their own credit score. Now the question is, what is a credit score, and why does it matter? A credit score is three digits, between 300-850, but there is no doubt that it has a huge impact on our buying power?
A credit score is basically a number that represents our creditworthiness. The higher the score, the better it will be for us while taking a loan, especially if we want to borrow money for big-ticket purchases.
It Doesn’t Start At Zero
It is one of the most common questions that many young people who are just beginning to build their credit ask about what their initial credit score is. Does it start with zero? Well, beginning with no credit does not necessarily mean that your credit score is 0; there is no such thing as zero credit score. Rather it will mean that your credit score does not even exist, and the main reason is that your credit score is measured at the moment when the moneylender or credit card issuer requests to scrutinize your creditworthiness. So if you have never opened any sort of credit in your life, then your credit score is not even going to occur at all. As per the FICO, the least scoring criteria are:
1. Minimum one credit account opened for six months or even more.
2. Minimum of one credit account was reported to one of the main three credit bureaus within the last six months.
You should note that you can meet the requirement even with a single account. But if you have not even started, then this means that there is no data or information available on which the calculation will be based. After beginning your credit history, you might assume that your credit score starts from 300 points, but it’s highly dubious your first credit score will be that little unless you begin with very pitiable credit conduct. However, your credit score will neither be at the highest level, especially when you are starting. You don’t have a healthy credit history to get a top-level score.
Depending on what type of credit line you open will determine what your credit score is going to be. It can be anywhere on the spectrum, but for most people, it’s normally going to be in the middle of 600 points to the mid of 700 points when you are first starting out. Let’s say someone is 18 years old and just got a student loan. He is probably going to be sitting around 650 to 750 credit score starting out, which is really good. Now the thing that is holding them back from having an exceptional score is just low usage of credit. Actually, a credit score is not an indicator of your financial well-being. Instead, a credit score is only an indication of how well you repay the debt amount.
How many points does it take to go up or down on a scale of 300+ points?
First, you need to understand the FICO credit score ranges. The score actually ranges from 300 to 850 and is divided into different classes.
Very poor: The score ranges from 300 to 579 come in this category, which means that your credit score is very poor.
Fair: The credit score of 580 to 669 means that your credit score is fair.
Good: If your credit score is between 670 to 739, then it will be considered as good.
Very Good: A score from 740 to 799 is considered very well.
Exceptional: If your credit score is 800 to 850, it means that you fall in an exceptional category. You repay the loan amount on time. Financial institutions will most likely provide you with a loan on minimum interest rates.
Now the question here is how many points it takes to go up or down on a scale of 300 plus. Your credit score goes up or down due to many reasons and the fluctuation of the score is a common thing throughout the month as the latest info is added to your credit report. You may be able to point to a particular occasion that leads to the fluctuation of the score. For instance, paying late or a new collection account will drop your credit score. Contrary to that, if you pay your high credit card balance, then your score will go higher. Each credit bureau uses its own algorithm to calculate your credit score; therefore, it is difficult to tell how many points will go up or down. Normally, mortgage companies don’t average the score on all three bureau’s credit reports; instead, they take the mid score of the three bureau reports when calculating your risk of defaulting on a borrowed amount.
Factors Which Make Up Your Credit Score
Now, there might be a question in your mind about how your credit score is calculated. There are several credit scores, but a majority of moneylenders (90 percent) use the FICO score. As per the FICO, these percentages refer to the general population, but it differs from one individual to another. Your FICO score is actually based on five factors. Each factor has its importance in the formula.
Payment history (35%): Your history of timely payments is the most crucial factor that makes up your credit score. This contains the annals from credit cards, retail accounts, and finances, and also the communal annals such as insolvencies. Even if you make the least payment, the important thing here is whether you have made such payment on time. For instance, if you make a late payment, the scoring formula will consider how much time you took for the late payment, how much amount was owed, and how fresh the felony was.
Accounts owed (30%): About 30% of your FICO score is based on the amount you are indebted to lenders. This is calculated through your credit utilization ratio. This is like how much loan you have taken versus how much limit is available for taking the loan. You need to keep the minimum percentage of your credit boundary both overall and on each credit account. For instance, if your credit card has a limit of $2000, then try to keep the outstanding balance under $600. If your balance is high, try to pay it as soon as possible. After you pay your loan amount, then it will increase the level of your FICO score.
Length of credit history (15%): This also plays a key role in building and maintaining your credit score and includes the time you have been using credit. This includes the period of your oldest credit account, the average period of your overall accounts, and the period of every single account. Normally older is considered better because the credit bureau can have more data about you.
New credit (10%): This includes 10% of your score. This category comprises credit inquiries and new credit accounts. When you try to open a new credit account, then a hard credit inquiry is made to scrutinize your credit. This is pertinent since those people who apply for many new credits in a short time could be seen posturing a bigger repayment danger to lenders. If you have made many inquiries about the credit, then it will be considered as you will most likely take more debts. A couple of inquiries can negatively influence your FICO score.
Credit Mix (10%): There are two kinds of credits. One is the installment credits which comprise car loans, personal debts, mortgages, and student advances. In the installment credit, you take a certain amount of loan and then repay such amount in the form of a fixed monthly installment. The other kind is revolving credits, which includes credit cards that enable you to spend up to a particular limit, and then you can repay such an amount either in a lump sum or you can carry it as long as you want by making the least payment.
How Can A Credit Score Affect Your Purchasing Power?
So the moneylenders evaluate several factors, such as your earnings per year or in a month, your current amount of loans, the percentage of the down payment, and also the most important factor is your credit score when you apply for a house loan. These factors give the data to the lender whether you are a responsible borrower or a perilous borrower. If the lender investigates the data and thinks that you are a riskier borrower, then he will most probably not grant you the loan amount.
It also influences the kind of loan and the interest rate that will apply to your loan. If your credit score is low, then it may not qualify you from buying a house, or if it qualifies you to buy a house, then the lenders will almost kill you with the high-interest rate and additional insurance requirements. It means that you will pay an extra monthly payment and also a higher aggregate amount of return.
For instance, if you want to take a $400,000 loan amount in the form of a fixed-rate mortgage of thirty years, and you have an exceptional credit score which is between 800 to 850, then the financial institution of the moneylender might charge you 3.3% interest. This means that you have to pay $1,754 per month. However, if your credit score is not exceptional, let’s say it stands from 620-639, and then the lender will charge you 4.9% interest, which means that you now have to pay a monthly installment of $2,122. Now you can have a pretty good idea of how much a credit score matters, as now, after having the score ranging from 620-639, you have to pay a $368 additional amount every month. Think for a minute about what you can do with an extra $368. And over the life of the loan, you will have to pay $132,686 more than if you had an exceptional credit score.
Now that you understand how crucial your credit score is when it comes to securing a good loan if you have a bad credit score, you need to repair it as quickly as possible. Otherwise, you will miss a lot of opportunities for taking credit from banks or other financial institutions. If you want to build a good credit score, remember it may take time as there is no shortcut to making it to the top level. On the other hand, if your score is below 740, then try to improve your credit score before you go for the mortgage. You can use a few tips to make small improvements.
The first thing that you should be careful of is, do not open fresh lines of credit with balances like taking a car loan or furniture loan before you apply for the mortgage loan. Then pay down any credit cards or the borrowed money but don’t close the account. This will show that you are a reliable money borrower and you return the money on time.
After that, try to check the balance to make sure that there is no outstanding rent, utility, or other bills.
In a certain case, if you have unintentionally missed the payment, then try to pay it as soon as possible and request the lender to remove the report for the late payment from your account. If you are a reliable person and you give a strong reason for the late payment, the lender will most probably make the adjustment. You can also try to make your payments automated to avoid late payments.
Make sure that if you have multiple accounts, and you pay one of them down, make sure that you are not letting the other one up at the same time. Otherwise, of course, you are going to counteract the one you pay down. It’s not going to have any positive impact on your credit score.
Also, maintain a decent debt-to-income ratio by maintaining your credit card balance under 25% of the obtainable balance. You should also apply for a secured credit card. A secured credit card is basically, where you are going to put money down, and you are going to have a limit for that amount. For instance, I gave my credit union $400; they are going to give me a credit card for $400, so this means that I have a maximum credit limit of $400. So you can make purchases on that card and pay it off regularly by making your budget.