Your credit score is the first thing required by lenders, insurers, landlords, and others when deciding on crucial financial and non-financial matters.
Your credit score can have drastic effects in the long term as it directly impacts the financing decisions made by the lenders.
What is a Credit Score?
A credit score is the statistical representation of your creditworthiness. It is the summary of your financial strength as reported by three credit bureaus Experian, Equifax, and TransUnion.
Personal credit scores are either issued by FICO or Vantage. The most widely used FICO credit score ranges from 300 to 850.
Then, the FICO credit score is categorized as:
Poor: 300 to 579
Fair: 580 t0 669
Good: 670 to 739
Very Good: 740 to 799
Excellent: 800 to 850
When Do You Need a Credit Score?
A credit score represents your creditworthiness. It is the summary of your financial history and transactions.
Lenders and insurers are the major users of credit scores. They want to learn how you have performed previously with financing facilities. If you never had a credit score, it will count as a disadvantage for you.
Similarly, some non-financial transactions like applying for a new utility connection or rental will require your personal credit score as well.
In a nutshell, a credit score shortens the financial scrutiny of an applicant and helps lenders decide quickly.
Understanding Credit Score Components
Understanding what makes up your credit score will help you realize how important it is for your financial strength.
This section accounts for 35% of your credit scores. It shows your repayment timing, missing payments, default, and completed loans.
It accounts for 30% of your credit score and shows how much debt you currently owe to lenders. It is particularly important for borrowers with existing credit cards, mortgages, and auto loans.
Length of Credit History
The length of your credit history accounts for 15%. It means the longer the credit history the better it is for you.
It accounts for 10% of credit score weightage. It includes the number of credit account types like a revolving credit facility or a fixed-term loan.
Your new credit applications and recent debts weigh 10% of your credit score.
Importance of a Credit Score
Once you understand which components create a credit score, you’ll know how lenders utilize a personal credit score.
Access to Financing
A credit score allows easier access to debt financing from licensed lenders. You can apply for credit cards, mortgage loans, auto loans, and personal loans easily when you have a credit score.
Negotiating Loan Terms
Lenders will assess your personal financial history when analyzing any type of loan application. A good credit score means strong financial credibility.
Therefore, a credit score helps you negotiate better loan terms with lenders including extender loan maturity and lower monthly installment amounts.
Negotiating Interest Rates
Generally, lenders will charge higher interest rates to borrowers with bad or no credit scores. If you have an established credit history and maintained a good credit score, you can negotiate better interest rates.
It is particularly important for borrowers looking for refinancing their existing loans.
As mentioned above, a credit score is not essential only for lending but for non-lending decisions as well.
For instance, landlords will ask for a personal credit score before finalizing a rental deal. It can affect your monthly rentals as well as the amount of security deposit with the landlord.
Similarly, you can negotiate better insurance plans with a good credit score.