Welcome to I Am Your Target Demographic. Today we’re going to outline something called
a credit score, which is really focused on the United States, but other countries likely have
something similar to help mitigate the risk of lending money to someone, or giving them credit.
If you’re getting a credit card or buying a house, the person on the other end
needs to know that you can make payments for example, so there’s a process to look at your
history and give you a numerical score. Your score also determines the interest,
which is a percentage that you’ll pay extra in order to get that loan.
The higher the interest, the more money you’ll pay beyond what you’re actually owing.
The idea of a credit score as we know it is fairly new, with these scores really originating
in the late 1980s. Before that, it was up to the lender to make that call, and there was a lot of
discrimination at play, basing these decisions on factors that really weren’t applicable.
In 1974, we saw the passing of the Equal Credit Opportunity Act,
so someone couldn’t be denied credit based on things like gender, race, marital status,
and more. So a system was created to assign this score in an ideally unbiased way that would apply
across the board, a score that could tell a possible lender what they needed to know.
You’re not born with a credit score, you usually need to open an account first, something like a
credit card. After three to six months, you’ll likely be able to retrieve your score. See,
this lender reports information to what are called ‘credit bureaus’ which are essentially databases
that track where you have accounts, your payment history, who is wanting to know your credit
and more. It’s these bureaus that ultimately report back and help decide your credit score.
To get your credit score, the largest three credit bureaus, called Experian, Equifax, and TransUnion,
report back your information and weigh them against a lot of factors,
which we’ll touch on in a second. There’s a few different strategies for creating this number,
so you might see some references to a FICO score, or something called a VantageScore, which
take the same data provided to them but manipulate and analyze that data in different ways. For some
odd reason, these two main versions of your credit score start at 300 and max out at 850. If you know
your score, let’s look at which scores mean what. Since there’s varying methods to create a score
and the bureaus may have different information sometimes, here’s what the scores typically
mean. In the 300-579 range, your score is poor. A bit higher from 580-669 is considered fair.
We then jump to good from 670-739 and very good from 740-799. Lastly,
800 to 850 is considered excellent. The better the score, the more you’ll be approved for credit
and the lower you might have to pay in interest, since it’s not a huge risk to lend you money.
Now that we’ve established that your score is a snapshot of your likelihood to make payments back,
what determines that? What factors into your credit score?
The most important factor in determining this number is your payment history,
accounting for about 35% of what makes up your credit score. Whether you’ve only had credit
for six months or for twenty years, how often are you making payments on time? If you’ve shown that
you’re reliable and making at least minimum required payments, you’re less of a risk.
About 30% of your score is tied to how much debt you owe. If you have three cards and you’re making
minimum payments, that’s great, but it doesn’t look great if your cards are all maxed out.
Loans you have, including student loans, home loans, and auto loans,
all factor into this as well. Those two factors contribute the most,
so the best advice to improve your score is to make payments on time and try to
put a dent in the amount total that you owe. Now, a tip here. You might think having no balance
would be best. Three cards, paid off completely. That actually might lower your score as well.
Not making monthly payments doesn’t show the same kind of reliability, at least in
the eyes of these credit bureaus, so keeping a low and manageable balance on each is key.
The next category of what determines your score is your length of credit history,
counting for about 15%. Having a card for six months is great,
but it shows much more if you’ve had a credit card for twenty years and consistently made on-time
payments. So your older accounts mean more. If you pay off your home, car, or student loan,
you might not see an increase in your credit score, because those accounts are likely pretty
old. Closing those accounts also lessens the amount of accounts you have in total, also
potentially hurting your score. It’s not always intuitive on how these all factor into your score.
At about 10%, it matters about the type of credit you’re using.
They want to see a diversity of types, to prove that you’re reliable in different ways. For
example you’ve got an installment plan to pay off a car, that’s a set amount, versus a credit card
that might have fluctuating costs from month to month and doesn’t end if you pay off your balance.
The last 10% is for how often people are checking your credit or you’re applying for new credit,
doing what are called ‘hard inquiries.’ What they’re trying to see is if you’re applying
for ten different credit cards over the span of a week, maybe you’re at a higher risk of making
those payments. Luckily, they tend to bundle some things, so if you’re getting comparisons for a
car and you go to several places, it’ll likely count as one hard inquiry of that type. If you
see something called a ‘soft inquiry,’ it means that they’re checking your credit but it won’t
impact your credit score, you’re not actually applying for additional credit.
Now, those categories are likely the same for everyone, but you might see the percentages
differently based on what you’re trying to borrow or how long you’ve had credit.
This is just a typical outline for most situations but isn’t black and white across the board.
So if you’re young and just getting your first credit score, hopefully this helped understand how
to get and then maintain a positive score. Focus on payments, not having a huge balance on your
accounts, keeping the older accounts you have, trying to get a diversity of types of credit,
and not applying for a lot of credit all at once. Hopefully you found this interesting and make
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