A credit score is actually a really simple concept. It tells someone you want to borrow money from how likely you are to pay them back. The higher the number, the more likely it is you will pay them back. We like to think of it as your financial reputation.
“Ok, so there’s this number that people use as my financial reputation, so what?”
Even though it might seem like just another number, your credit score is actually one of the most important numbers you will have in life. You might think that your IQ or perhaps your income is more important, but without a good credit score it can be really hard to enjoy life. The following are just a few reasons why your credit score is so darn important.
When making a purchase like a car or a home, it is nearly impossible for most people to come up with all the cash needed to pay for it up front. As a result, most people will look to borrow money to help pay for the purchase, and take on debt that they will need to pay back over time. Loans like this are just a fact of life if you want to make big purchases, and aren’t necessarily a bad thing if care is taken. Learn more about debt and how it works in our article on debt basics.
Your credit score can decide whether or not a lender will let you borrow money from them. And if they choose to lend you money, your credit score will significantly impact the terms of that loan (think interest rate, and required down payment).
Take a look at the tool below to see how your credit score impacts how much you’ll end up paying for a loan.
You might think that the impact of your credit score is limited to loans on big ticket items, but bad credit can actually cause your insurance rates to go up. Some insurance companies use something called an Insurance Score. Although not all insurance companies use an insurance score, when it is used, it closely resembles your credit score.
Your credit history will be used to help determine whether you are a risk to insure. If you have a rocky credit history, insurers believe that you will be a higher risk, and end up charging you more for an insurance policy.
It works on the other side too! If you have a stellar credit history, they believe you have lower risk and will charge you less for the same insurance policy.
Insurance companies must ask you for permission before pulling your credit, which will typically be a soft pullA soft pull on your credit (also known as an involuntary inquiry) is a credit check that won’t negatively impact your credit score. This is because it happens when you are not actively seeking out new credit (a loan, new credit card, etc.) on your credit.
In a similar vein, potential employers can pull your credit with permission to help them make a decision on whether or not to hire you. The thought being that, if you have good credit history, you are more likely to be a responsible, proactive employee.
Obtaining a job applicant’s credit history is especially common for jobs that require handling of sensitive information or need a security clearance.
Finally, it is routine for landlords to run a credit check (a soft pull) on potential renters before accepting their rental application. Simply put, if you have good credit, you are more likely to pay rent on time and will have a better chance of having your application accepted. Just like the previous examples, this can work for you or against you depending on your credit history.
It is important to understand that there are many different ways to calculate your credit score, but they all use roughly the same information. That information is called your credit history, which is maintained at three different national credit bureaus (Experian, TransUnion, and Equifax). Each credit bureau does their best to maintain an accurate record of your credit history, but slight differences in what each company has on record is common.
Two of the most common scoring methods are the FICO score and the VantageScore. Regardless of the exact formula used, these are the factors that will impact your score:
When it comes to your credit score and credit history, we don’t want to fool around. As you saw earlier, your credit score can mean the difference between being approved to buy a house or not. Or even whether or not you get that job you applied for!
With this in mind, it’s important to check your credit frequently. Check your credit once a year at the very least, or monthly if you really want to be on top of things. This will help you understand how your credit score changes over time, and catch any errors that might occur. You can typically check your credit through your bank or credit card company, or a trusted third party like Credit Karma.
If you find an error in reporting, fix it right away by notifying the reporterThe reporter is the company that passed along incorrect information to the credit bureau. This could be a credit card company, mortgage company, utility company, etc. and the credit bureau where the mistake has been made.
Most of the time the fastest way to report an error is through online forms for each credit bureau, although you can send mail or call. Below are the links to each credit bureaus online dispute form:
So, should you lead with your credit score on a first date?
It still might not be the best approach… but we hope you now see how important your credit score is, and are now armed with some information that will help you improve your financial life.
Understanding the factors that impact your credit, where to check it (or dispute it if things are off), and how your credit can have a significant effect on your life are the first steps towards becoming a personal finance rock-star. Still more to learn, but a great start.