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Consumer debt is a big issue. Debt can take the form of credit card debt, student loans, auto loans, mortgages and personal loans. The loan amounts continue to increase every year in the United States. According to Experian, the average credit card/retail card balance is over $7,000. Clearly, it is a good financial step to read Understanding Your Credit Score for Beginners, but understand that the algorithms behind a credit score is anything but simple.
Credit scores are an increasingly important aspect of your financial health. It is a critical factor in determining if you can get a line of credit, loan amounts allowed, and the interest rate associated with the loans.
Additionally, the rules are changing in 2020. Don’t be surprised if your credit score drops.
Now is the time to know your credit score, what the score means, and how to improve it.
Know Your Credit Score and Get Your Credit Report
You can get your credit report free annually with no impact on your credit score. Equifax, TransUnion and Experian are the three nationwide credit bureaus. The federal government required that we have free access annually. If you have not requested your credit report, do that first.
Fun fact: The credit report and associated score may differ between the three credit bureaus based on how creditors report the information.
What your Credit Score Means?
The FICO (Fair, Isaac Corporation) score range is between 300-850. FICO is the most commonly referred to score for determining your credit worthiness. People fall into 5 categories with roughly 20% of the population falling into each category. The 5 wonderful categories are:
Experian Consumer Credit Review stated that the average credit score in 2019 was 703.
I look at it like a grading system A-F. The exceptional students (A students) are going to get all the goodies. They are the teacher’s pet and will get the best interest rates, the most credit line, bigger loans, etc.
The good students (C students) are going pass the class, but not get everything they want. They might get the loan, but not the best interest rate. The very poor students (F students) are not likely to even get the loan.
The goal should be to move up the categories and obtain the Very Good or Exceptional Rating. It gives you the most leverage with your financials.
Fun fact, your salary has no impact on your credit score.
Two Types of “Bad Scores”
There are two key types of “bad” scores.
1. The most often talked about is having a crappy credit history. For those with a crappy credit history, it is going to take time and you need to be perfect moving forward to dramatically move your credit score.
2. The other situation is not having a lot of credit history. If you are reading this article on credit score for beginners, you are likely in your 20’s. Part of a credit score is building a credit history, so young people will typically have lower scores than the more seasoned individuals. Yes, it is a form of discrimination.
Best Ways to Improve Your Score
In trying to keep Understanding Your Credit Score for Beginners simple, three meaningful ways to improve your score regardless of your current situation:
1. Pay Your Bills on Time and in Full
This means all bills from student loans to utility bills. Direct payment can help manage this process.
2. Check Your Credit Report for Errors and Get Those Errors Addressed
Don’t be surprised if there are errors on your credit report. It happens all the time. The important thing is to get the errors corrects; so that, the errors don’t impact your credit score.
3. Keep Your Credit Utilization Rate Low
What does that mean? It means don’t max out your credit cards every month. You want to keep your total balances well below (like no more than 25% of the total) what is allowed by the companies holding your credit lines. It is just part of the calculation, which is not obvious to the average person.
With the FICO calculation being updated, #1 and #3 will be even more important. There are more factors that go into your credit card score, but these are important factors that really drive your score.
Credit scores become important when wanting to borrow money. We might not agree with the how credit scores are calculated, but our opinions do not really matter.
It is more important to understand the game and take steps to succeed at the game. A Very Good or Excellent credit score improves your ability to finance future purchases. It is really that simple.
If you are interested in taking the next steps in becoming financially independent, consider taking the Whippersnapper Finance 9 Week Financial Challenge .
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Good Luck, Whippersnapper Finance