Understanding Your Personal Credit Score

Anyone who needs to gauge how responsible you are financially — from landlords and employers to lenders like banks and auto dealers — checks your credit score. The score, which ranges from 301 to 850, helps them determine how risky you are as a debtor and how high an interest rate to charge.

Does It Affect My Business?

Defaulting on a personal loan could stunt the growth of your small business. The Fair Credit Reporting Act (FCRA) allows lenders, in some instances, to take the personal credit histories of sole proprietors into account for business lending purposes. Viewed from a different perspective, this means that boosting your credit score could help you get a business loan approved. It could also save you thousands over time in interest payments.

With so much at stake both personally and professionally, it’s essential to understand how credit scoring works and how to maintain an excellent credit score.

Who & What Determine Your Credit Score

Each consumer technically has multiple credit scores computed by various companies and retailers. The most relevant scores however are those computed by the three national credit bureaus. Experian, Equifax and Transunion, all use variations of the FICO Score algorithm. This algorithm uses the patterns in hundreds of thousands of credit reports to approximate a consumer’s level of future risk. While your score might vary slightly across the three, each uses roughly the same formula.

  • Payment History (35%) - this considers how promptly (or not) you pay your bills.
  • Outstanding Debt (30%) -  how much of your available credit you’ve used, and how close your card balances are to their limits.
  • Length of Time (15%) - having used credit responsibly for many years will boost your score.
  • New Credit (10%) - opening several new credit accounts and having lenders conduct hard inquiries has a temporary negative effect on your score.
  • Types of Credit (10%) -  experience with different types of credit accounts, such as mortgages and store accounts, can positively affect your score.

How to Boost Your Personal Credit Score

Maintaining a good credit history over a long period of time may sound tedious, but there’s no quick fix for a low credit score. The following tips offer foolproof methods for raising and maintaining those three digits.

Pay Bills on Time. There’s no way around this one. Do whatever it takes: set up payment reminders, seek out a credit counselor, or establish automatic payments. Never ignore overdue bills; the longer you wait (30, 60, or 90+ days), the more detrimental the impact on your score.

Check Your Credit Report. You’re entitled to one free credit report from each of the major credit unions every year. Your credit score is calculated from this report. Check it regularly. (Only one in five consumers takes advantage of this right, each year!) Look out for errors and dispute them with the relevant credit bureau.

Do not confuse your report with your credit score. You can buy your credit score or check it for free during a trial period or in exchange for marketing and advertising. (Read this Knowzy article for tips.) While checking these sites won’t cost you any points, a hard inquiry by a lending institution will affect your score. Limit the damage by limiting your loan shopping and inquiries to within a couple weeks.

Manage Debt. While it’s generally better to owe less, it’s important to demonstrate your ability to pay back low balances. A good rule of thumb is to keep your card balance below 30% of the limit, if possible. Lenders want to know that you don’t overextend your credit and that you are able to repay your debts.

Handle New Credit Carefully. There’s no shortcut to a good credit score. If you’re new to credit or are looking for a mix of credit types, don’t open a slew of new accounts suddenly. Each new account has a temporary negative effect on your score. Keep in mind that a closed account may still be factored into your score.

Use Credit Cards. Opening a credit card as early as possible is good for your credit. Paying off revolving credit, as well as installment loans, is one of the best ways to build up your credit score. Don’t close unused cards; they can help your debt-to-credit limit ratio. Cutting all your cards or using just one is a tempting simplification, but having two or three well-established credit card histories is a great way to boost your score.

Whether or not you plan to apply for a loan in the next few months, spend some time to understand and maintain an excellent personal credit score. It is one of the best investments you can make for future growth.

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