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Credit Score: What is it? Why is it Important? How are credit scores determined?

Have you ever thought about buying a new car? Or have you ever dreamed of owning a home some day? Well, your credit score plays an important role in fulfilling both of these tasks and many more. A credit score is a number representing an individual’s creditworthiness. This number is based on past and current credit decisions and files. A credit score is based on information pulled from reporting credit bureaus. A credit score is based on a scale of numbers ranging from 300 to 850. The higher your credit score the better. A higher credit score can potentially lower interest rates for big purchases in life. If you wanted to buy a car, or a house, or even wanted to apply for a credit card, a higher credit score (normally 720 or above) will help you receive lower interest rates and potentially higher credit limits on credit cards.

Now that we know what a credit score is and why it is important, let’s talk about what determines your credit score. There are five key components used in determining credit scores. Myfico.com is a really helpful tool in determining how each of the 5 categories affect your credit score differently. The five components are:

  1. 35% of your credit score is based on your payment history
    1. The first component is really important. Initially a lender wants to know whether or not you have paid past credit and bills on time. A few late payments won’t wreck your score, and no late payments doesn’t mean you will have a perfect score. Just aim to pay all bills and payments on time. One easy way to assure payments are made in a timely manner is to set up automatic payments. Always strive to pay more than the minimum balance if possible, preferably the full amount due.
    2. If you have made late payments in the past and are looking to improve your credit score, start by making on time or early payments on all credit and bills. This will help improve your score and it will look good to lenders to see that you are making payments on time.
  2. 30% is based on the amount you owe compared to the credit you have available
    1. This next component can be kind of confusing. When a person is using a high percentage of their available credit, it may indicate to lenders the borrower is using almost all available credit, not paying off the high balance, and may be more likely to make late payments.
    2. If you use too much of your total credit available, you will hurt your credit score. Use the credit utilization ratio to determine how much credit you are using. Try to keep your utilization around 30%
  3. 15% is made up of the length of your credit history.
    1. For this component of your credit score it is all based on your credit account histories. The longer that you maintain an account with a lender or creditor the better it is for your credit score and the more favorable it looks.
    2. Myfico.com talks about how FICO Scores take into account how long it has been since you used certain accounts, how long accounts have been open and the average age of accounts.
  4. 10% is based on the variety and number of accounts you have. I look at it as, “how often do I shop for credit and open new accounts?”
    1. Next, don’t apply for too many accounts in a short period of time, because this hurts your credit score.
    2. Each time you apply for a loan, credit card, and other financial related accounts, where they check credit, it affects your credit score, so try to keep this number as low as possible
  5. 10% is based on the kinds of credit.
    1. Lastly, this component is based on the different type of credit accounts you have. They prefer to see a mix of credit cards, loans and other forms of credit.
    2. For example if you have 4 credit accounts and they are all credit cards, this area of your credit score could be improved by adding a loan into the mixture if you ever need one. It is all about variability.

Everyone can check there credit score for free at www.creditkarma.com. Know this number and work on making it as high as possible, because the higher it is, the better. As we mentioned earlier, a good credit score brings you several benefits and allows you to achieve financial goals and dreams you may have.

To obtain a free credit report visit the official site at www.annualcreditreport.com. Everyone is entitled to one free credit report every 12 months from the three credit bureaus TransUnion, Experian and Equifax. This site will only provide a credit report, not your credit score. Many lenders will review a credit report to determine the risk associated to the borrower.

If you have any questions about getting your credit score, establishing a credit score, or improving a credit score and would like some help, please make an appointment with Powercat Financial Counseling. You can make an appointment at our website: www.k-state.edu/pfc. We provide free and confidential counseling to all K-State students.

Miranda McMahon                                                                                                                             Peer Counselor II                                                                                                                                   Powercat Financial Counseling                                                                                                              www.k-state.edu/pfc