Financial Literacy Month: How to Understand Your FICO Score

Financial Literacy Month (1)

 

If you google the definition of credit, here’s the definition you’ll find for credit as a noun: ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future.

For people that you know well and trust like your friends, neighbors and family have credit. I know if I let my grandma borrow my vacuum she will return it to me. I know that because we have built trust in each other over the years. Likewise, I also know that if I leave pizza within the grasp of my brother it will disappear if he finds it. I have a pretty good idea of what to expect from the people in my life, but how to lenders know what to expect from people who want to borrow from them?

They don’t. Until someone found a way to give lenders an idea of how people handle their financial obligations, the credit score. That someone was the Fair Isaacs Corporation, or FICO for short. In the late 1950s they found a way to mathematically evaluate lending risk to help businesses with making better decisions. They have released several different versions of their scoring system over the decades with the most current being the FICO Score 9. There are several things that make up your actual score: payment history, credit mix, length of your credit history, how much you owe on your current debts, and new credit accounts. Each one is weighted differently but just over 60% of the score is made up of your payment history and the amount you owe on your debts.

There are 3 different credit bureaus that keep track of your credit history- Equifax, TransUnion, and Experian. When your credit is in question, businesses can contact the bureaus for information about your creditworthiness. However, the information that each bureau has might not be identical to another due to when information is reported and how they report the information. This can result is differences in the scores that are reported.

Generally, scores range between 300 and 850. Anything above 690 is considered good credit and 720+ is considered excellent. If you find yourself below 690, that’s okay. You can get it up into the better range. Why do credit scores matter? If you will ever have a need to borrow money, then you want to be able to be in the good to excellent range. If you want to get a car loan, the better your credit is the better your loan terms will be because you appear as less of a risk to the lender. This could look like you having a lower interest rate for the duration of your payments. But it’s the not end all of every decision, there’s also your employment history, income, and other factors. So, I hope you are not evaluating your self worth on your credit score. You can definitely be successful in life if your credit score isn’t phenomenal. You may have to do things differently but you are not doomed. In the case of the car purchase, you could save up the money and pay for it in cash and then it won’t matter what your credit score is. Please don’t let this number cause you stress and dismay. If you want to focus your energy on raising it so you can qualify for a mortgage or reach any other goal that’s okay. As long as you remember that your credit worthiness and your self worth are not the same, okay?

If you have decided that you want to start raising your score, here are some things you can do:

  1. Get organized so you can start making more on time payments, this is a large chunk of your score
  2. Try not to open more new accounts because having newer cards lowers your average age of accounts. The longer your history is the better.
  3. Avoid closing credit cards that have a higher limit because it will increase your utilization and the goal is for it be lower.
  4. Check your credit report for negative items and mistakes to dispute. You can check out this post for more information on that.

If you’re interested in getting your FICO score you can go to My Fico to learn more about how to get those scores and they also offer credit monitoring.

Is your credit score important to you? Comment below to let me know!

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