Understanding Credit
These days, it’s more important than ever to have good credit. Banks, landlords, and even prospective employers want to see your credit score. But what exactly is “credit”? Put simply, your credit score shows what banks think of your ability to pay back your debts.
If you have bad credit, it means banks think you are at a high risk of defaulting on your loan, or not paying back the money you owe. If you have good credit, it means the banks believe there is little risk that you won't pay back your loan.
Bad vs. good credit
When you have bad credit, it’s difficult to get or use borrowed money, such as a credit card or loans for a car or a home. If you have good credit, it's easier to get new loans, open a credit card account, and borrow more money if and when you need to.
Credit scores
Credit bureaus look at your history of using credit and they calculate your credit score. A credit score is called a FICO score, which stands for Fair Isaac Corporation. A credit score can range from 300 to 850. Usually a higher score makes it easier to qualify for a loan. It may also result in a better interest rate.
Many factors can affect your credit score, which is a number that is assigned to you based on your history of borrowing money and paying it back. These factors include:
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If you have ever missed a payment on a bill or paid late
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If you have had bankruptcies, garnishments, liens, or judgments on your record
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How long you have been using credit
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How many different types of credit accounts you have in all, such as credit cards and loans
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How much credit you have compared with how much of it you're using. For example, how high your credit card balance is compared with your limit
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How much total debt you have
How your credit score changes
Your credit score can change often, both in good ways and bad. If you borrow more money, miss a payment, or use up more than 50% of your limit on a credit card, your credit score will drop. If you pay off a lot of your debt and pay all of your bills on time, your credit score will go up. That is, it will get better.
Why your credit score matters
Banks use your credit score and history to decide whether to offer you more credit or loans when you apply for them. They also use this information to determine the interest rate at which you will pay back any money you borrow. If you have a low credit score, you’ll often be charged a higher interest rate on your loans and credit cards than people with good credit scores. This means that over time, you will pay more money to pay off your debt.
Improving bad credit
If you have bad credit or are having trouble paying off your debts, credit counseling services are available to help you pay down your debt at a more affordable rate. Talk with them about how their services will affect your credit score in the meantime. You can also try contacting your credit card companies yourself to see if they can help you find a way to pay down your debt in a more manageable way.
It's a good idea to check your credit regularly to look for any errors. You can get a free copy of your credit report once each year at www.annualcreditreport.com or by calling 877-322-8228. This report does not include your FICO score, but the score can be purchased when you request your free credit report. A credit report includes details of your identity and employment, your existing credit, public information, such as tax liens or legal judgments against you, and credit inquiries made about you.
You can also take these simple steps to improve your credit score:
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Automate your bill payments to make sure that you meet all your due dates.
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Don’t charge up more than 50% of your credit card limit. That alone will lower your score.
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Pay down your debt.
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Keep your old credit cards open even if they have been paid off. A longer credit history means a higher credit score.
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If your credit report has errors, contest them and get them corrected.