The basics
There are three credit reporting agencies. These agencies collect and track data every time you make a payment towards your credit card balance.
Credit reporting agencies collect and track every time you pay off any amount of your balance or apply for a line of credit. A mathematical formula is then applied to this financial track record. The result? A three-digit number generally ranging from 300 to 900. Unlike many health indicators, the higher the number, the better. A good score is typically around 700.
To understand your credit score you need to know how it’s calculated. There are a few areas that control your credit score. Let’s break them down.
One of those areas is your payment history which accounts for 35% of your score. Do you pay your bills on time? Has a collection agency tracked you down? Have you declared bankruptcy?
Another 30% of your score comes from the amount of debt. Have you maxed out your credit cards? A good rule of thumb is to use less than half of your available credit (a quarter of your available credit is ideal).
Think of the balance of your credit score coming from three different buckets — the amount of time you’ve had credit, the different types of credit in your report and any new credit.
The longer your credit history, the better the “mix” of credit (i.e. cards, loans) and the fewer examples of “new” credit, the higher your score will be.
Why it all matters
If you’re looking to get a mortgage your credit score determines a lot more than you think. Because the credit score reflects a borrower’s history of paying bills on time and responsible use of credit, a borrower with a higher score has a better chance of consistently paying off the mortgage. Some lenders base loan interest rate on your credit score, giving higher rates to less creditworthy applicants. Which means if you have been using your credit wisely, you’re likely to receive a lower interest rate than a less creditworthy counterpart.
Like we mentioned earlier, your credit score can do much more for you than allowing you to get a more favorable mortgage loan. Shopping around for car insurance, looking to rent an apartment or house, or signing up for a new cell phone plan? If you answered yes to any of the above, chances are a good credit score will make your life easier. Oh, and the money your score will save you isn’t bad either.
It pays to keep your credit score healthy!