Personal credit and the credit scoring system can oftentimes be confusing. It seems nowadays that you cannot do anything without first checking with the credit “gods”. In this review of how personal credit works, I discuss in detail what a personal credit score is, how credit scores are calculated, how banks use your credit history to make lending decisions and some quick tips on how to improve your credit. Personal credit is not the only factor that goes into lending decisions, but it is definitely important.
What is a Personal Credit Score?
A personal credit score is a three-digit number derived from the data in your credit report that indicates how likely you are to repay a loan on time in relation to other borrowers. Typically, this number can range from 350 to 900. Correspondingly, a lower score means banks will consider you a higher risk customer.
There are three personal credit bureaus: TransUnion, Experian, and Equifax. Although most of your credit report will be the same across all three, there can be differences.
You may have heard of the word FICO or VantangeScore. These are the models to calculate the credit score. Each of these companies may have several different versions of their score for different end uses (for example, one for mortgage lenders, one for credit card banks, another for car insurance companies and even for home utility companies).
FICO
FICO Scores, which are used by 90% of lenders, are a highly trusted measure of whether a loan will be paid on time. FICO’s algorithms calculate your creditworthiness based on the information found in your credit report. Comparatively, other types of scores simply use payment history to calculate your score.
Typically the FICO scoring model looks at 5 key factors; Payment history, Amount currently owed, prior credit history, new credit applications and what type of credit your currently have.
How Banks use your Personal Credit Score
Today, companies use the data in your credit report to create credit scores. Most lenders will use this score in the underwriting process as an alternative to manually reading your credit file. To clarify, underwriting is the process where the bank looks at your financial, tax and credit documents to offer you a loan.
That said, you can expect an underwriter to look more closely at your credit report when applying for a large loan such as a mortgage or a personal loan. Your credit score and financial information are important factors that affect the interest rate you receive.
Think of the personal credit score as a financial report card. The credit reporting agency monitors how you use your money and how you pay your bills. It will then give you a grade. Institutions use this grade to confirm you are trustworthy enough to get more financial responsibility.
Why is this important?
Having good credit can offer an individual a lot of opportunity. Personal credit can be used not only as a consumer, but as a business owner as well. Personal credit can be a very easy way to get business start up capital. This can help pay for many of the initial decisions of a business.
This discussion goes more into the concept of good debt versus bad debt. Obtaining credit to fund potential business ventures can be very profitable. Correspondingly, It is first important to understand how your financial decisions affect your creditworthiness.
Having good credit is extremely important to save money. If you have good credit and are looking to purchase a home, you can save hundreds of thousands of dollars based upon a better interest rate. For example, if you are buying a home and the purchase price is $350,000 dollars, the difference in total interest payments is $153,890 on a 30-year mortgage between a 4% interest rate and 6%. Just a two percent change on the interest rate causes over $150,000 dollars more in payment.
Sometimes, companies will use your credit score for other decisions, too. Have you ever applied for a job, rented an apartment, used cable, internet or electric? How about applied for car insurance? Typically, all of these items will require some form of credit check to either be approved. In addition, if good personal credit is an issue for you, typically you are required to pay a higher deposit. You may not get approved at all.
How to Improve your Personal Credit Score
Now that we understand how important the credit score is, let’s discuss some quick tips on how to improve the score. In order to improve your score, you must look at improving all the factors that go into creating the score. I have broken down into five categories that can assist in improving the score below.
There is no blanket formula for improving your credit score. Therefore, I would encourage you to reach out to a credit repair company if you want advice tailored to your specific situation. Below are the 5 quick tips that may help:
5 Quick ways to Improve your Credit Score
- Get a free credit report: This will allow you to know what is on your credit report. More often than not there are things on your credit report that shouldn’t be there
- Enlist the help from a credit repair company. This will help to either remove errors or offer a debt consolidation loan to refinance all the debt into one payment
- Build a budget to understand how much money you are spending monthly. Set a reminder for each bill that you must pay to pay it on time
- Pay the highest interest card first and then moving to the next card. Once paid off, do not cancel the card. Available credit will actually increase your score.
- If possible, get a side hustle that can offer you additional income to help you pay off the debt faster. As a matter of fact, there are many work from home opportunities out there where you can set your own hours.
Check out this Work from Home Opportunity – Click here to watch a short video
Conclusion
Personal credit is very important and not something to take lightly. Good personal credit can not only save you hundreds of thousands of dollars but also open financial doors that otherwise would not be available. That being said, there are many ways to improve your credit score. It is vitally important to first understand your credit situation, set financial goals and stick to a budget. Only then can you really have the financial knowledge to fix the issue.
I hope you enjoyed this post on personal credit. Go ahead and take a look at the Savings and Investing post for additional tips on personal finance. My goal with these posts is to offer financial education. Hopefully, also offer viewpoints other than what is popularly thought. Credit and debt can be incredibly useful tools. They can fund start up capital for businesses and assist in leveraged purchases. The more you know about credit and the general banking process, the better off you will be.
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