As you get older, wiser, and start to earn your own income, your finances become a lot more important to you. They can determine your spending habits, how you invest your money, where you live, and more. Besides the amount of money you’re earning and how you choose to spend it, there are other things that have a substantial impact on your day to day life. In this case, we’re talking about your credit score.
But why do you need a credit score?
There are many reasons why you need a credit score. Your credit score is an important number that can be used to measure your creditworthiness when you apply for a credit card or loan, or even when you want to buy a car. A good credit score can give you more access to favorable loans, credit cards, lower down payments, and so much more.
In the first chapter in our credit series, we went over the credit score definition and what your credit score says about you. But in this chapter, we’ll be answering important questions like “what’s the point of a credit score?” and “how can I build my credit?”.
To learn more about why you need a credit score and its importance for your financial future, continue reading the post or use the links below to skip to the section you need.
Why Do We Have a Credit Score?
The answer to the question “why do we have a credit score?” is actually quite simple: Your credit score determines the loans you get and the rates you pay. Your credit score can seriously impact your financial life, and there are various side effects of bad credit.
For example, a good credit score can help you get a low interest rate and down payment on a home, but a bad credit score might prevent you from getting approved for the home loan at all. If your credit score isn’t exactly where you want it to be right now, don’t freak out. There are many ways you can optimize your credit score, and we’ll be discussing credit building tips later on in the series.
Your credit score is based on your credit history. According to the Federal Trade Commission, credit history is defined as the way in which you use your money—how many credit cards and loans you have, whether or not you pay your bills on time, etc. Your credit history tells a story that gives lenders and other entities insight into your finances. All of this information goes into something called a credit report.
Credit history vs. credit report
A credit report is a summary of your credit history that includes information such as:
- Your name, address, and Social Security number
- Your credit cards and loans
- Your credit balance
- Your payment history (i.e. whether you pay bills on time or late)
Your credit report also features a number, called a credit score, that gives a high-level perspective of your credit health. Financial regulators, lenders, and credit reporting bureaus have assigned categories to differentiate bad credit scores from average and good credit scores.
To make matters more complicated, there are two types of credit scores that lenders and other entities use—FICO and VantageScore. Each of these scores have their own scoring systems. Let’s take a look at the different credit scores and what they mean:
- Poor: <580
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800+
- Superprime: 781-850
- Prime: 661-780
- Near prime: 601-660
- Subprime: 300-600
Note: Intuit uses TransUnion VantageScore to provide customer credit reports.
The typical credit score in the U.S. is around 675, but this varies by age and state. It’s important that you know how to check your credit score so that you can stay on top of any changes and errors that occur. You should also know how to dispute items on your credit report, like if your name or social security is wrong. You don’t want incorrect information on your credit report that could be negatively impacting your credit score.
Why you need a credit score
The way you manage your credit accounts, how much you’re spending on credit, and whether you pay on-time all contribute to your credit history, and therefore, your credit score. As we alluded to in the introduction, your credit score is a very important figure in monitoring your financial wellness. Here are a few reasons why it can be a good idea to focus on building your credit history and establishing good credit.
Having a good credit score can:
- Make it easier to open credit cards, loans, and other new lines of credit
- Help you get a better mortgage rate
- Increase your eligibility for lower loan and credit card rates
- Give you better negotiating power with lenders
- Speed up the process for home and apartment rentals
- Lower your car insurance rates
How to check credit history
Now that you understand the importance of establishing a good credit history, you’re probably wondering, “how can I check my credit history report?”.
The law states that every year, you can get a free copy of your credit report. You can request your credit history report by calling 1-877-322-8228 or visiting AnnualCreditReport.com. Your free credit report will give you a detailed overview of your credit history, payment history, lines of credit, and more.
Additionally, you may also contact your bank or credit card provider to see if they include credit reporting as part of your membership plan. Or, get started with Mint to access your free credit score today.
How to Build Credit if Your Credit History is Limited
The best way to establish a good credit history is slowly, over time. Make payments on time. Pay off balances as you go, or at least keep them reasonably low. Keep your debt to credit ratio low. As the years go by, all your responsible behavior can help you build a good credit history.
You say you can’t wait to get started? Let’s take a look at seven tips for building credit so that you can raise your credit score as quickly as possible:
1. Consider a secured credit card
Even if you have a short credit history, you may still be able to qualify for a secured credit card. For this type of credit card, you deposit cash that serves as your credit limit.
Consider any fees and charges when deciding between secured cards. And be sure the card you choose reports your account activity to the major credit bureaus including TransUnion®. Not all cards do this, so you want one that highlights your great track record.
2. Ask about credit where you bank, shop, or get gas
If you already have a savings or checking account, your bank may approve you for a card with a low credit limit.
You can also try applying for a gas credit card or store credit card. These usually have smaller credit limits, but it’s often easier to qualify for them. Gas credit cards are usually good at only one chain of gas stations, but you can take advantage of discounts and perks. Store credit cards are also limited, but they often offer rewards like cashback, points for certain purchases, or benefits like free shipping.
3. Talk to lenders before you apply
For people without long credit histories, some lenders may examine data from less traditional sources, like utility or rental payments. If your credit history is relatively brief, it’s perfectly appropriate to ask your lender if they’ll look at alternative data when they’re considering your application. Just do it before you apply—asking after you’ve been denied may be less effective.
4. Look into a credit builder loan
This works on the same principle as a secured credit card, except it’s a loan.
Here’s an example of how it works. Let’s say you take out a small loan from a bank and then use that loan to open one of their Certificates of Deposit (CDs). The bank holds the CD, while you make regular payments on the loan. When you’ve paid off your loan, you own the CD. You end up with some savings, plus a good credit track record.
The downside? Any interest and fees you have to pay on the loan. Be sure you choose a lender that will report your on-time payments to the three major credit bureaus. And try to find a bank that offers low rates and fees.
It’s also important to be aware of the pros and cons of paying off a loan early. Paying off a loan early means you’ll be in less debt and you’ll pay less on interest, but it can also potentially lower your credit score if it’s the only loan account you have. So before you go ahead and pay off the loan in full, do some research to figure out if it’s the right choice for you.
5. Become an authorized user
You can ask someone (usually a family member or close friend) to add you as an authorized user on their credit card. That way, the account’s history will be added to your credit report.
Of course, you’ll want to choose a person whose account is in good standing. There’s always the risk that they could miss payments, end up in collections, or even go bankrupt. In that case, their bad behavior could hurt your credit report. So, if you do become an authorized user, monitor your credit report to be sure there are no issues and payments are being made on time.
6. Don’t apply for multiple credit cards at once
Applying for lots of credit cards all at once may seem like a good way to kickstart your credit history, but it can actually hurt your credit and raise alarm bells for card issuers. Be selective. Look for the best rates from brands you know.
7. Be careful about closing accounts
When you finally pay off a credit card bill, you might be tempted to immediately find out how to fix a closed account. But getting rid of a closed account isn’t always the right decision when it comes to your credit history.
Closing credit accounts may significantly shorten your credit history. Accounts you close will eventually stop appearing in your credit reports and won’t be calculated in your credit score.
Here’s an example:
Let’s say you have two credit cards: one with a $20,000 credit limit and zero balance and another card with a $10,000 limit and a $5,000 balance. If you decide to close the $20,000 limit card because you no longer use it, this may negatively affect your utilization ratio (the amount of debt you’re using compared to the amount you have available), your credit score and your credit history. So unless a card has high fees, consider leaving it open. Make a few small purchases every so often and pay them off monthly.
Key Takeaways: Why Do You Need a Credit Score?
Building your credit history is an important step to take in managing your finances. Before you go off to build your credit history and start practicing good credit habits, keep these key takeaways in mind:
- Where can I check my credit report? You can access a free credit report each year via AnnualCreditReport.com, or request your free credit score with Mint today.
- Does a credit report show credit score? Yes, your credit report will feature important metrics regarding your credit history. This can include your credit score, identifying information, payment history, and more.
- Do I need a credit card to establish a credit history? Opening a credit card is a great way to start building your credit, but there are other options that can help you get started. Secured credit cards, store credit cards, credit builder loans, and becoming an authorized user on a relative’s account are a few examples to consider.
Your Credit Score Is Essential to Financial Wellness
With the above in mind, you can see why your credit score is so important and why it should always be top of mind when it comes to your financial health. So now that you know the answer to the question “why do you need a credit score?”, you can move onto the next chapter in the series, where we’ll be discussing the various factors that affect your credit score.
Start keeping track of your budget and overall financial wellness by learning more about Mint today.