How to get a better Credit Score by understanding how they work

“Do you have good credit or bad credit?” If you’re like me, this question might be just as confusing as the question “Are you a good witch or a bad witch?” I mean what exactly IS “good credit” and “bad credit”? What do people mean when they talk about “credit scores”?

If you’re like me, talking about money, or anything for that matter,  can be confusing and/or boring if you don’t know what you’re talking about.

Crazy words like 401K, stocks and bonds, inflation, compound interest, investments, stock exchange. Sometimes I start thinking I would have an easier time learning Japanese than trying to understand what on earth accountants and financial experts talk about all the time, but once you start to understand these words, at least for me, they become super interesting, and Practical.

You’ve come to the right place.  Here on this channel, we translate the scary unknown into simple terms that the average person can understand and use.

This video will help you decipher the “Greek” of credit scores. After watching this video, you will understand three core things about credit scores: 1) how credit scores work, 2) how they’re calculated, and 3) why they’re important in your future.

 

1) How credit scores work

What is “credit”?

In the credit score world, the term “credit” simply means your reputation as a borrower and it has to do with your history of staying on top of loans and credit cards.

Some of you may be scared by getting a credit card or going in debt, but debt is simply a tool used to manipulate money. It’s not good, or bad, but it can be used in great and terrible ways.

Before lenders will sign off on loans with you or open a new credit card for you, they find out your personal credit report. The credit report tells them your borrowing history. Based on the credit report, the lender determines how much to charge you for the loan and whether to approve your loan or not. So, whether it’s taking out a loan to help pay for college, a new car, or a new house, credit scores are super important.

 

2) How credit scores are calculated

Who determines your credit score?

Credit scores are determined by credit bureaus (or credit report agencies). But to get your credit score, you have to start with the credit report.

Credit bureaus are simply companies that gather your financial information onto a report called your “credit report.” In the U.S., there are three main credit bureaus: Equifax, Experian, and TransUnion. The Fair Credit Reporting Act, issued by the government, sets standard guidelines for all credit agencies to follow when reporting on your credit.  Other businesses (like lenders, banks) can buy your credit report from the credit bureaus.

These credit bureaus use computer programs to analyze the credit report and give you a “credit score.” This software scans the report for qualities, patterns, and potential pitfalls in your borrowing history.

This credit score is usually what most lenders look at. With so many loan applicants, they don’t have time to wade through pages and pages of each person’s credit report. So they just come up with a number. Credit Scores make it easier and faster to determine loan eligibility for applicants.

What exactly is ON a credit report?

Well, lots of things. But let’s be more specific.

 

If you really want to see what’s truly on your report, just go sign up at creditkarma.com, that’s what I use and they let you see your report, and also give you a free credit score update for free every week. If you don’t monitor your credit report and score very often, someone could be stealing your identity without you knowing it.

Credit reports gather information about specific credit history “events,” so to speak.

They list things like:

  • amounts you’ve borrowed
  • your payment history (whether you’re on time, or have any late/outstanding payments)
  • whether or not you have any outstanding loans (that may or might not be in the “collections” status)
  • any loans you’ve had in the past 7 years (whether you’ve paid them off or not)
  • current loans
  • any minimum monthly payments you’re making
  • instances of foreclosure or bankruptcy

What factors make up your credit score?

Each credit bureau puts out a credit score, or a FICO score. FICO credit scores range from 300 to 850. The score is made up of the following factors:

-10% Type of Credit – auto loan, home loan, credit card

-10% New Credit – credit seeking activity, statistically if you are seeking lots and lots of credit in a short amount of time, you are seen as riskier, which makes your score go down and your interest payment go up. They check these by hard inquiries, which is anytime a lender checks your score.

-15% Length of Credit – oldest account, neweest, and average age

-35% Payment History – largest amount – bad/good delete 7 years

-30% Amounts Owed – credit utilitization, which is the percentage of how much you’ve borrowed over how much you can borrow total. On a credit card you might have a limit of 1000, and if you use 200 of it, your credit utilitzation will be 20%. Experts say keep it under 30% to stay in the clear, and under 10% for best results.

 

Here’s where “good credit vs. bad credit” comes in. A high credit score is a sign of a good borrowing history. The lower your score, the harder it will be for lenders to approve your loans. THey will see you as risky. It’s common for lenders to set “rules” their applicants must fit in order to sign a loan with them. Like one lender might not approve scores under 650. This same lender might approve scores between 650-720, but give them a high interest rate. Then for scores over 720, you might get a low interest rate.

3) Why credit scores are important in the future

So like we said before, good credit scores are important for securing loans. Securing loans means that you are better equipped to accomplish your purchasing goals like buying a car or house, or paying for college. Cause face it, if you’re not rich, you’re going to need some loans to help cover such huge, necessary expenses. And even if you do have a ton of spare change laying around, it’s a good idea to keep some credit active to keep your score high. So the question is not “will you borrow” but “when you borrow.”

I want to make this very clear. If you use a credit card correctly, you will not have to pay ANY interest. I’ll cover it in a later video. Credit is not BAD, it is when you use it irresponsibly that it can have downfalls. For some people, like me, paying $400 on interest for a car loan is worth the 150 point increase over 3 years to be able to get a lower interest mortgage.

1) How do I get a copy of my credit report and credit score?

You can get a free credit report by going to AnnualCreditReport.com.

Credit scores are a bit harder to get. Hard, but not impossible. One easy way is to ask your lender for your score, next time you set up a new loan.

CreditKarma is what I personally use and there’s an app I downloaded to check it weekly.

Another way is to look for your FAKO score. This is your credit score that other credit agencies can calculate for you. They based it on some of the similar things that the FICO score looks at, however these FAKO scores do not use the same algorithm that the main credit bureaus use to get your FICO score.

Note of caution: be careful when scanning the web looking for your credit score. Like with anything online, some places are legit while others are scams.

If you want your FAKO score, here are some legitimate places we’ve already scouted out for you (you’re welcome!): Quizzle, Credit Karma, Credit Sesame, and Credit.com.

2) What can I do now to make sure I have a healthy credit score?

It’s never too early or late to start improving your credit score. There are some easy ways to get and keep a good credit score. 18 is the prime age to start working on your credit score.  Here are just a few suggestions to get you started.

-Pay your bills and loans on time. Sounds like a no-brainer, but seriously this is one of the easiest and most important ways you can have good credit. You can increase your effectiveness of this by having a monthly budget where you track your money.

-Diversify your types of credit. This just means that you have different types of credit in your borrowing history. Different credit cards, different loans, etc. One easy way to do this is to have a credit card or two, but make sure to pay it down to $0 each month—this will increase your credit score.

-Be a wise consumer. If you’re like me, it’s way easier to spend money than save money, especially if you aren’t tracking it. But try to base your spending decisions on what you need, not what you want. This will ensure that you don’t overspend on impulse buy, which can sometimes cause you to default on your current loans or payments (which is a sure-fire way to lower your credit score).

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