Why Do Credit Scores Matter?
Your credit score is represented by a number, most commonly between 300 and 850, that is used to predict your “creditworthiness”. Your current credit score is a culmination of your entire credit history that paints a picture of how likely you are to pay any future debts reliably. It’s updated continuously on your credit report.
Each time you pay — or don’t pay — a loan, credit card, or other monthly payment, it is reported to one or more of the credit bureaus. When you consistently make payments on time, your score goes up. If you make a payment late or not at all, your score goes down. Your score is also affected by other factors, such as the ratio of credit used vs. total available credit, age of current credit accounts, and age of your entire credit history.
Having a higher credit score is advantageous in a number of ways. A higher score means you will pay lower interest rates on car loans, mortgages, and basically every other type of loan. Many auto insurance companies factor credit scores into their rates as well, which means you may pay a lot less for car insurance if your credit score is very good. Even some employers use a candidate’s credit rating as a point of consideration during the hiring process.
What Are the Different Types of Credit?
While all loans and credit accounts will consider your credit score, there are a few kinds of credit accounts that all work a little differently.
- Installments: Loans such as auto financing and mortgages are considered installment credit. There is a predetermined loan amount that is divided into payments across a specified period of time. Generally, each monthly payment is for the same amount, and you know exactly how much you need to pay and for how long.
- Revolving Credit: Credit cards and other lines of credit are considered “revolving” because the balance and available credit fluctuate according to how and when you use them. As you pay down your balance each month, more available credit opens up. As you spend more of your available credit, your payment amount increases.
- Secured Credit: Often taking the form of a credit card, a secured credit account requires a monetary deposit from the customer. The cardholder can then spend up to the amount of the security deposit they provided. Functionally, this is like using a bank account’s debit card that also helps to build up a consumer’s credit history and score.
How to Improve Your Credit Score
Making sure to consistently pay all current credit obligations each month is crucial. A missed payment can reduce your score by as much as 100 points.
The higher your current balance compared to your total credit limit, the lower your score will be. Keeping a low or zero balance will improve your score.
Each time you apply for a loan or credit card, a “hard inquiry” appears on your credit report. Several hard inquiries in a short amount of time will drop your score.
It’s not extremely uncommon for erroneous items to appear on a credit report. A simple clerical mistake can have a serious impact on your credit score.