Mastering Credit Scores for Empowered Financial Decisions
Credit scores are three-digit numbers that represents the likelihood of an individual paying back what is borrowed. Credit scores are important to know in several key situations where your financial health and capability are assessed by others.
When Your Credit Score Really Matters
Here are some of the main circumstances when knowing your credit score is particularly crucial:
- Applying for a Loan or Mortgage: Lenders will check your credit score to determine your eligibility for a loan and the interest rates you will be offered. A higher score generally means more favorable loan terms.
- Credit Card Applications: When you apply for a new credit card, issuers will look at your credit score to decide whether to approve your application and to set the terms of your credit, such as your limit and interest rate.
- Renting a property: Many landlords use credit scores to assess potential tenants’ reliability. A higher score might improve your chances of securing a rental and could reduce the requirement for a larger security deposit.
- Employment Screening: Some employers check credit scores as part of the background check process, especially for positions that involve financial responsibilities or handling money.
- Insurance Premiums: Insurers may use what’s called a credit-based insurance score to determine your premiums for auto and homeowners’ insurance. A better score can lead to lower premiums.
- Planning Financial Goals: Knowing your credit score can help you understand your financial standing and guide you in improving your financial health, which is beneficial for long-term planning like buying a house or saving for retirement.
- Before a Major Purchase: Checking your score before making large purchases or undergoing significant financial transactions can give you a better sense of what financial products you might qualify for and help you negotiate better terms.
When a bank or other creditor pulls your credit report, that is when your score is automatically calculated by the computerized mathematical system. Whatever information is in your file at that moment is used to calculate your score. It is not saved, and you cannot use it for future pulls. It will only matter for that situation.
A high credit score most significantly influences the interest rate you’ll be offered on a loan. This is without a doubt, the most impactful aspect because it directly affects how much you’ll pay over the life of the loan.
As an example, on a 30-year mortgage of $300,000, someone with an excellent credit score might receive an interest rate 1-2 percentage points lower than someone with a fair score. This difference could save over $100,000 over the life of the loan.
The Impact of a High Credit Score
Beyond interest rates, a high credit score also influences:
- Loan terms – You may qualify for longer repayment periods or more flexible options
- Down payment requirements – Particularly for mortgages, you might qualify with a smaller down payment
- Fees – Many lenders reduce or waive certain fees for highly qualified borrowers.
- Loan amounts – You’re more likely to be approved for higher loan amounts
- Documentation requirements – Some lenders may require less documentation for high-score borrowers
- Speed of approval – The process may move faster with fewer verification steps.
The interest rate impact remains the most significant financial benefit, as even small rate differences compound substantially over time, especially on large loans with long terms.
FICO Scores and Other Scoring Models
There are different providers for credit scores. This includes:
- Free credit scores from third party websites.
- Credit scores from websites that provide credit monitoring services.
- VantageScore credit scores.
- SageStream LLC credit scores.
- FICO Credit scores.
FICO scores are used by approximately 90% of top US lenders in their lending decisions. Including most major banks, credit card companies, auto lenders, and mortgage lenders.
FICO does not share their scoring models with anyone, so be aware of websites that offer free credit scores. because scores you receive are not accurate. Many scores from third party websites give out scores that are usually high. There can be a 20-to-70-point difference, which sets you up for disappointment later.
To earn a credit score, you need:
- One credit card open for more than six months.
- One credit card used at least once in the past six months.
- The credit account is not under dispute for accuracy.
- No notice of passing away
The credit score will be a number from 300 to 850. The higher the number, the less of a risk you are. Within this range, there are 5 tiers.
- 800-850 Excellent
- 740-799 Very Good
- 670-739 Good
- 580-669 Fair
- 300-579 Very Poor
How Many Credit Lines You Need for a Good Score?
With one credit account, you can only earn so many points. For a 740-credit score, you will need three lines of credit established for one year, paid as agreed and a low usage ratio. Paying your credit cards on time isn’t enough to get a high credit score.
You need to have the right amount of credit and type of credit. Although there is a fine line for having too much credit and the right amount of credit. Too much credit will deduct points from your credit score. Having three credit cards earns the most points for that characteristic.
Anymore than three credit cards will deduct points for the individual. However, 10% of your credits score considers type of credit. No points will be earned for the credit mix factor with just three credit cards. The perfect mix of credit is three credit cards, an installment loan, and a mortgage.
A mortgage holds the most weight, installment loans next in line, credit cards hold the least weight. Payday loans and cash advance loans are considered risky. Even when paying them on-time you lose points for that type of loan . They are considered risky because lenders view it as being hard up for cash, hence they are known as hard money lenders.
Credit Inquiries and Their Effects
Another factor in scoring are inquiries. There are 2 types of inquiries:
- Soft Inquiry: Current creditors will pull their customers credit report as a check-up. It is a way to minimize their risk. These inquiries have no impact on your credit score. Although, if a lender sees that their customer is beginning to make late payments on their other accounts, they may raise the interest rate to off-set the increase of risk of being paid late or maybe not at all.
- Hard Inquiry: These inquiries will impact your credit score. These occur when applying for a line of credit. No one can pull your credit without your consent. They will stay on a credit report for two years. But it’s only the first year that your credit score is impacted by it.
There are over 50 million Americans with credit records. No one is watching over anyone’s credit. Credit scores are not calculated day by day. If your score was calculated day to day, your credit score would change frequently. At least once a month, due to the billing cycle.
Whenever information is deleted or added from your file, it will have an impact on your credit score. Like mentioned above, when a bank or other creditor pulls your credit report, that is when your score is automatically calculated by the computerized mathematical system using a complex 40 component algorithm, at that very moment.
The Five Levels of Credit Scores
FICO’s scoring system is confidential and complex. There are 5 factors that make up your credit score:
- 35% of your credit score is influenced by payment history.
- 30% is influenced by debt ratio.
- 15% is relies on the length of credit or the age of your credit accounts.
- 10% is reliant on types of credit.
- 10% is from credit inquiries.
Within those categories are characteristics. A scorecard will contain a list of about 20 characteristics being measured—each one either adds points if it’s seen as a good behavior or takes away points if it’s considered risky.
When the points for all the characteristics are added together, the result is the final score for each individual. It’s a way to predict future behavior based on past patterns. The points that are gained or lost do not have a set number. The number of points lost or gained depends on what the rest of the file looks like. In addition, part of the credit scoring method is based on a grading curve, comparing your file against the rest of the population at that moment.
Improving Credit Scores
It’s too complex of an algorithm to try and understand it, so you can beat it. Nothing can make up for paying off your balance on time. No one is going to report that you made a payment if you didn’t. Now, you could get lucky and a mistake could occur, reporting that you paid when you didn’t. But majority of errors hurt your credit, rather than help it. Remember that your credit score is based on your credit profile. The only things that matter to your score are:
- Keeping a low balance to limit ratio.
- Paying your bill on time.
- Paying off the entire balance when the bill comes.
You can forget about all the credit score advice, if you consistently focus on the 3 things above. A great credit score is going to be attached to it. As you can see from the chart, that those who have 800+ credit scores, like clockwork, are never late with a payment and keep low debt to limit ratio below 10%. The main difference from someone who has grade A credit and someone who doesn’t, is the individuals who have 800+ scores, they cannot think of any reason why someone would not pay off their balance when it is due.
The most important factor in scoring is paying your credit accounts on time, every time. When you sign the agreement for a credit line, you are agreeing that you will pay the balance in full and on-time. And if you don’t, you agree to pay the consequences. Including the high late payment fees, and interest on any amount that rolls over from one month to the other.
When a balance is carried over month to month, a lender sees it as an individual living above their means. Going over one’s budget. And the system will dock points for carrying a balance.
Although a high credit score will influence many aspects, it will not guarantee loan approvals. Remember the credit score is just an indicator.
When a lender or creditor pulls your report, they receive a detailed report of your accounts, balances, payment history that includes paying on time/ paid as agreed. Whether you made a partial payment or paid the balance off. You earn small number of points for paying on time and in full because that is what’s expected. You signed the contract. You lose a lot of points for a late payment. A late payment can drop your score up to 100 points.
The lender or creditor also receives a credit score from each credit bureau. The lender will use the middle number of the three.
But it’s the credit report that hold the majority of weight in lending decisions. If you want to boost your credit score there are tactics that can be applied. But nothing can replace the weight of an excellent credit payment history. That takes time to build.
If you have an excellent credit history of paying on time and in full, a late payment is going to drop your credit score severely but as time go on it will impact it less and less. However, the history prior to the late payment is stellar. Maybe you had some issue pop up and you were late with your payment, big deal it happens.
Then, if you take a credit report that has several late payments scattered throughout the credit history. The individual may not lose as many points as you do with a late payment. But the lender is going to be hesitant in approving a loan. The interest rate will be high, but with what they see in the details of the report is the individual pays the balance off at first. Then they begin making partial payments. Not too long after, they are late with payments.
Another line of credit may overwhelm the individual. Will the borrower default on the account. Eventually, it becomes a collection account. Is it worth it to the lender? That’s up to the lender to decide. If everyone paid their accounts in full and on-time, lenders and creditors wouldn’t make any profit.
How to Time Credit Pulls Effectively
The fastest way to boost your credit score is to pay down a high balance. Focus on cards closest to their limits—paying those down has the biggest impact. You can even make an extra payment before the statement closes to lower the reported balance.
Ideally, you’ll attain the right amount and type of credit, so you receive the maximum points for that characteristic. Then you don’t need to apply for anymore lines of credit. If you can be disciplined enough to pay the balance off on time every due date. Credit cards have high interest rates by default. But if you always pay the balance in full, interest rates won’t matter to you.
It’s not like your going to be applying for lines of credit very often. But when you do, this is the strategy. The moment the credit bureau updates your file with a lower balance, you credit score goes up in theory, because your credit score is not a running tab. And any previous credit score does not mean anything at this point.
We know that the credit bureaus update your electronic file once a month. And we know that the creditor reports your payment history to the credit bureaus about every 30 days. Creditors do not report on the same day. But you can call your creditor and ask what day they do report. Typically, they report when the bill is due. The bureaus will update your file not too long after. Anywhere from the same day up to a week after.
This is important, if you pay down a high balance on august 21, and the creditor reports on August 23. But you consent to have your credit pulled August 22. Your credit will be pulled too early. And the boost to your credit score will not help when it matters most.
If you understand this, then you can time your consent to pull your credit at the right time.to the best effect. Alternatively, you can request to raise your credit limit. But creditors have requirements for an increase in credit limits. These two tactics have a direct effect with your balance-to-limit ratio. You’ll earn the most points when your credit cards have a $0 balance at the time your credit is pulled.