Financial Learning: Why Does My Credit Score Matter?

Managing your credit score can be tricky, especially if you're new to applying for credit. This guide will help you understand this important financial concept.

If you borrowed federal student loans for college, you’ve already experienced the benefit and convenience that credit offers. By taking out your first student loan or applying for other lines of credit (like your first credit card), you’ve started the foundation of your credit history and now have a credit score. Every subsequent credit-based activity you conduct moving forward will affect that score, including your repayment history, the types of credit you open, and other factors. If you’re new to the credit world, this guide will walk you through how scores are created and the importance of keeping yours high.

What exactly is a credit score?

A credit score is the number that represents your creditworthiness, with a higher number indicating a stronger score. This number is issued by three credit bureaus: Experian, Equifax, and TransUnion, all of which have their own methods of calculating your credit score. Lenders you’ve borrowed from in the past routinely report your credit account activity to the bureaus. Information such as payment activity, outstanding balances, the age of your account, and whether your account is delinquent or in default all inform how your credit score is calculated. The most widely used scores by lenders and creditors are the FICO Score and VantageScore, both of which range between 300–850. In the US, the average FICO Score is 711, while the average VantageScore is 688. Although different scoring models might use the same score range, the formulas used can vary greatly. 

Aside from simply acting as an archival log of credit activities, your credit score is important to lenders you’ll work with in the future. They use it as a reflection of how responsible you are in managing credit. With your credit score, they can better understand whether you’re likely to repay a loan or line of credit on time or if you’re a high-risk borrower who might not pay up. 

Related: A High School Senior Starter Guide to Financial Responsibility

Factors that affect your credit score over time

For the FICO Score, there are five components that affect your credit score positively or negatively:

  • Payment history: The most impactful element of your FICO Score is your payment history, which accounts for 35% of your score. If you make full and on-time monthly payments toward your loans or credit cards, you’ll likely have positive marks in this area. However, missed payments are reported to the credit bureaus by your financial institution, leading to a derogatory mark on your credit report that pulls down your credit score.
  • Amounts owed: Another factor that affects your credit is how much of your available credit you’ve used. Also called credit utilization, this affects 30% of your score. This percentage is important to remember because you’ll want to keep your credit utilization below it. For example, if you have a total credit limit of $1,200, it’s wise to keep your spending below $360.
  • Length of credit history: Having mature credit accounts in your history affects your credit score by 15%. Your first credit card is a good example of an aged, active account that’s advantageous for your score—if you’ve had this card in good standing for many years and it’s your oldest account, it’s best to keep it active even if you no longer use it.
  • New credit: New credit lines account for 10% of your credit score. This includes the number of recent inquiries like applying for new credit (regardless of whether you were approved), the new credit accounts you’ve opened, and how recently they’ve been added to your credit history. Lenders view a sudden onslaught of new open credit accounts and inquiries as a red flag that you might be facing financial challenges.
  • Credit mix: The final 10% of your FICO Score considers the type of credit you have. Installment credit has a fixed outstanding balance due, including student loans, mortgages, or car loans. Revolving credit includes credit cards, retail and gas cards, and home equity lines of credit, from which you can regularly draw funds. Even though this is a smaller percentage of your credit score, it can still affect it in either direction.

Throughout your lifetime, your credit score will change based on your borrowing habits and how you manage your credit accounts. If you use your credit lines responsibly by making on-time payments and keeping revolving balances low, you’ll have a better chance of building a high score. However, mismanaging your available credit by missing payments, defaulting on your credit obligations, or filing for bankruptcy will adversely impact your credit. 

Figuring out your credit score

Establishing a strong credit score can help you access more borrowing opportunities at competitive interest rates—and can even be a factor when renting an apartment or buying car insurance. Whether you’re just starting off with your credit history or looking to repair your credit, you can lift your score with some time and deliberate actions. The first step is understanding where your credit is today by requesting a free credit report, which you can order from each bureau through annualcreditreport.com. Although it’s rare, reporting errors are possible, and they can pull down your score. For example, if you and a parent share the same name, your parent’s credit information might’ve accidentally been reported and associated with your credit profile. Read your credit report thoroughly to ensure the details are accurate. If you find an inconsistency or mistakes, contact the credit bureau immediately. 

Related: Smart Money and Budgeting Tips for High School and College Students

Many businesses refer to your credit report to assess whether you pose a risk to its organization. Financial institutions evaluate your creditworthiness before lending you money, as do other businesses, like potential employers, landlords, or service companies. Nurturing your credit score will give you the advantage of being eligible for more affordable financing options and opportunities in nearly every part of your life. 

Interested in more financial advice for both school and postgrad life from this author? Check out Callie McGill’s other blogs and articles!

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About Callie McGill

Callie McGill is a Content Marketer for ValuePenguin.com.

 

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