Everyone has heard that it’s important to have good credit. Your credit score helps people evaluate how risky it is to do business with you. The most common reason someone will check your credit is to make a lending decision. But other people and institutions check credit, too. Utility providers, landlords, potential employers, and even cell phone companies check consumers’ credit histories.
There’s no mystery about how to establish good credit. Limiting the amount of credit you use, paying bills on time, and maintaining low balances are all great ways to build a solid credit history. Consumers should also be careful about how many times they apply for credit. The more someone’s credit is checked by lenders, the more wary other lenders become.
Some people believe that paying cash for everything but a mortgage is the wisest way to manage their finances. However, it’s tough to borrow a large sum of money if you don’t already have a credit history. Establishing a credit history early can be very prudent. In fact, some parents will work on building a good credit history in their child’s name, even when they’re a minor.
One common way to evaluate a potential borrower is by checking their FICO or credit score. There are three major credit bureaus in the US. These are Equifax, Experian, and TransUnion. Each calculates a credit score for consumers. Consumers are able to access their credit reports for free from these bureaus one time each year. A FICO score is a shorthand that helps lenders make quick decisions about borrowers. Most Americans have a credit score in the 300 to 850 point range.
Credit scores are designed to let lending institutions know how likely a borrower is to pay them back on time. The FICO score is influenced by 5 different factors: new credit, types of credit, length of credit history, payment history, and current loan/credit card debt. New credit accounts for 10% of your credit score. It refers to how many accounts have been opened recently. Types of credit in use accounts for a further 10% of score. Common types of credit include mortgages, installment loans and revolving debt.
Thirdly, the length of a borrower’s credit history is considered. Length of credit history accounts for 15% of a credit score, making it more important than the first two criteria. People who have a long relationship with banks and credit card companies, and who use credit moderately, are usually viewed more favorably by lenders.
The most important single factor in determining a credit score is payment history. This is more heavily weighed than any other factor influencing the score, at 35%. Making payments on time is very important to all lenders. That’s true whether they’re considering you for a mortgage or a credit card. Issues like wage attachments, foreclosures or court judgments against you will also be reflected in this category.
Finally, the potential borrower's current loan and credit card debt is also very important. This is weighted at 30%, or almost a third of the FICO score. This category evaluates how much the consumer owes on all open accounts and how much of their available credit they’re using. People with high credit scores keep their credit utilization low.
Credit scores are a good shorthand. But the actual number can vary wildly throughout a given time period, like a year. For example, one missed payment can have a huge impact on a score. This is true even if it’s just a simple mistake. For example, sometimes a borrower will accidentally double-pay one bill, and forget to pay another. That can still mean a big hit to their credit score. But accounts that have been in collections for a long time, which represents a more serious issue, have a less severe impact on a credit score.
This is part of why we don't use credit scores at Alliance Leasing. We’re more interested in the "hows" and "whys" of the score. We know that no one’s perfect and mistakes happen. But we do need to know the details of how accounts became delinquent, and how quickly that issue was resolved. That said, it’s important for consumers to understand where their credit score places them with lenders.
Credit Score Rating Ranges
This is considered “poor” credit. The score is below average for US consumers. Lenders consider these borrowers to be riskier.
These borrowers have “fair” credit. This score is still below average, but lenders may approve loans with these scores. The loans may have higher interest, making them more expensive in the long run.
Borrowers in this range have “good” credit. They’re slightly above average for American consumers. Most lenders consider this a good score.
This range is considered “very good.” It’s above the average for US consumers. Lenders see people with this kind of credit to be dependable and a good risk.
Anyone with a credit score of 800 or more is considered an “exceptional” borrower. They’re well above average compared to most American consumers. Lenders see these candidates as low-risk, very desirable borrowers.