Credit rating is a crucial factor not just in securing a mortgage, credit card or loan — it can dramatically affect everything from car insurance and mobile phone contract rates to overall employability.
What is a credit score?
Put simply, this is a three-digit number any lender looks at to estimate how risky a borrower you are likely to be: the higher it is, the better off you’ll be in terms of acceptability and interest rates. Lenders usually use the FICO credit scoring model — its scores ranging from 350 to 850 — and incorporate five factors when calculating it: payment history (30% importance), total amount of debt owed (25%), length of credit card history (25%), credit mix (10%) and new credit (10%).
If potential lenders see you've been financially irresponsible in the past, you could be in a pickle. (After all, would you lend your money to a person with a history of not paying their debts?) And there’s slim chance of keeping anything from them, since they’ll likely consult all of the big three credit reporting agencies agencies: Experian, TransUnion and Equifax. Credit mix, meanwhile, is an assessment of the various types of accounts in your name (including credit cards, student loans and personal loans), while the new credit numeral shows how many times you've applied for a loan recently.
Once your financial history and habits are thoroughly dissected, you get a credit report — a summary of payment history, credit accounts and balances. Logically, negative payment history can damage your score. Moreover, should you be more than 30 days late to pay a balance, you will likely be reported to one of the major credit agencies. Once this shows up on a report, you're marked as a risky borrower, which could stay on a report for up to seven years.
Related: Why Is My Personal Credit Score Used to Qualify for a Business Loan?
Building a credit score may seem like a daunting process, and in truth it does take effort and time, but there are specific steps to follow.
1. Build your credit file
This is a vital first step for laying down a good track record, and includes the opening of new accounts that will be reported to bureaus. Credit-builder loans or secured cards are great options if you're just starting out. A way to attain a higher score is by mixing different types of accounts. Although it may sound strange to own debt in various forms, it's proof of reliability as long as you're paying bills on time, which brings us to…
2. Maintain good payment habits
Payment history is one of the most crucial factors. It's simple: a long history of regular payments is the most important factor in score calculation, so make sure to keep track of loans, credit card balances and pay dates. And don't wait more than 29 days after the “payment due” date, since 30-days-late payments could get reported to bureaus. A wise move to do is set up automatic payments, while securing any associated bank accounts from overdrafts. And if you're having trouble putting together money for a bill, reach out to your card issuer to discuss options. It’s far worse to simply ignore the problem.