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Have you ever wondered why credit scores have become king in the financial world? This is a numerical figure that displays how a consumer behaves when it comes to credit. It shows how responsible you are in paying your dues, how many you have borrowed and other important details about your reaction to debt.
It was not always so important until a decade or so ago. Now, everyone is so concerned about keeping their credit score up. It rules a lot of their financial decisions and it is all for a good reason.
What is the importance of a high credit ranking?
If you want to improve your finances, you need to start paying attention to everything that involves your money. That includes your credit score. There are 4 important reasons why this is so.
Encourages financial responsibility. To be financially responsible means you must be in control of your money. You cannot be deemed responsible if you do not know what is happening your money. This is why paying attention to your credit score is very important. By monitoring your score you will be forced to look at your money and credit obligations regularly. That will help you practice the habits that will make you more responsible with your finances.
Allows access to financial opportunities. By keeping your score high, you will be getting a lot of financial opportunities. The most common is getting a low interest on your loan. A high credit score shows lenders that you are a low risk borrower and that prompts them to lower your interest rate. Not only that, potential employers also look at your credit report. It could mean losing your dream job if you do not take care of your credit ranking.
Warns you of identity theft. A lot of people ignore credit monitoring for the simple reason that they know they can control their credit obligations. Being responsible with credit is great but you have to look at your credit report every now and then to check for identity theft. Some people fail to notice that someone else already borrowed under their name and did not pay it. They means your credit history is tarnished and if you do not look at your score, that will keep you from acting on the theft immediately.
Keeps you from a financial crisis. By keeping an eye on your credit score, you will realize just when your debts are already getting out of hand. When you debts overtake your ability to pay for it, that will lead to some serious problems in the future. So by looking at your credit report regularly, you can gauge how much you owe and how much you can afford to borrow. This will keep your finances from potential ruin.
How is your credit score computed?
To monitor your credit score means you should understand how it is computed in the first place. You don’t have to do the actual computation yourself. In truth, the actual formula is unknown to the public. But you can use the online credit score estimators to help you determine your current score. Apart from the free calculator from the MyFICO website, you can also use the ones from Freecreditscore.com and Creditcards.com.
But to help you understand things further, there are 5 distinct categories that affect the figure that comes out as your credit rating.
Payment history. This is 35% of your overall credit score. This basically shows your payment behavior. If you had been late on payments, this is what will affect your score. By consistently paying your dues on time, you can keep your credit score up.
Total debt amount. The higher your debt is, the lower your score will be. This affects 30% of your score. So before you take in new credit or charge a purchase with your card, you need to consider how much debt you already owe. Not only will you be protecting yourself from the possibility of being unable to pay for your dues, you will also keep your score high. Pay off your current debts before you borrow more money.
Credit history. 15% of your credit score is affected by your credit history. Basically, your old accounts will help keep your score high. So try to keep your old accounts so it can contribute to at least 15% in your credit report. But you don’t have to just keep them open, they have to be active. That means you have to use it and keep on making payments on it.
Type of credits. This is 10% of your overall credit score. It may seem like a small part but you should not disregard it nevertheless. This part of your score involves the type of debts that you owe. Take note that 3 credit card debts are only counted as one. You need to have revolving and installment debts (credit cards and personal loans, respectively).
New credit. When you apply for a loan, the lender will pull out a copy of your credit report. This will be noted on your report and that can pull your score down - at least the 10% of your score.
These are all computed to come up with your credit score. So if you want to improve it you should pay attention to these 5 categories - especially those that have a bigger effect on your score.
To know more about credit scores, here is a video from one of the 3 major credit bureaus, TransUnion.