Everyone is on the loan train right now. Possibly, every person you meet has an outstanding loan balance or just got their personal loan approval. Your house might be a product of a home loan, or the car your neighbor is driving is currently on a car loan. Wherever you look, loans are involved.
As per the latest data from TransUnion, approximately 20.9 million Americans have an outstanding personal loan. And in the U.S., there’s an increase of 21.4 million to 23.4 million of personal loans being recorded, having an average new personal loan amount of $6,825.
Those numbers are dizzying, but did you know that before you can take out a loan, you need to build a good credit score? What does this imply, and why do you need a credit score?
What Is a Credit Score?
You might be wondering: what is a credit score? Technically, a credit score or a credit rating is a numerical representation of your credibility in paying credit back. The concept of credit scores is simple. The higher your credit rating, the better chances and terms you’ll get in taking out a loan. On the other side, the lower the credit score, the more difficult it would be for you to take out a loan.
Your credit score can be used on all types of loans. This means your credit score influences your chances of fast approval in getting a credit card, car loans, and mortgages.
FICO and VantageScore are the two most popular credit score models that many lenders use in checking your credit rating. They are called an analytic decisioning platform that helps businesses make better decisions, significantly predicting a consumer’s ability to repay a debt on time.
Why Is It Important?
The better question is, why do you need one? And the answer is simple: eventually, you’ll need to file a loan application in the future. If you think otherwise that you can take out a personal loan without a credit score, yes, you probably can. But that is if you’re ready to be charged with expensive interest rates with strict loan terms.
So, if you’re not ready to take that on, you need to start building your credit score. Building a credit score is easy, though, as there are many ways to start it from scratch. However, it’s important to emphasize that building and maintaining a good credit score is important for financial health. It can help you unlock many saving benefits, enjoy better loan terms, and access loans with favorable terms.
What Makes Up a Credit Score?
This is an essential aspect of getting to know your credit score. By learning and understanding this, you’ll know what comprises it. Five factors make up your credit score. They are the following:
Payment History: 35%
Payment history makes up a more significant percentage since it will tell the lender if you’re a good payer or not. Your payment history will be reported to credit bureaus, and it will reflect in your credit score. Any late payments will be recorded, how late the payments are, and the event’s frequency.
Amounts Owed: 30%
Maintaining a low credit card balance is good for your credit score. This is very important since it will show that you keep your credit card utilization ratio at a low rate, which means you’re managing your expenses properly so it won’t hit your maximum allowable borrowing limit.
Length of Credit History: 15%
Credit age or credit history is one factor that levels the playing field in the loan application process. If you have an old yet well-managed credit history, you’re bound to even greater loan terms and benefits the next time you file for a loan. Healthy yet old credit history is made up of continuously paying your bills on time (full payments) or reducing the amount you owe.
New Credit: 10%
Every time your lender conducts a hard check/inquiry, your credit score is affected as well. These inquiries are shown in the new credit category in your report. So, if you want to save that 10%, only apply or open a new credit card when you need it. If you need your credit score checked, don’t go overboard.
Credit Mix: 10%
Credit mix means how many accounts you currently have in your report. Diversity is the primary key here, so if you have multiple credit accounts in your report, the better.
A combination of the following accounts will help improve your credit score.
- Credit Cards
- Installment Loans
- Retail Accounts
- Mortgage Loans
- Finance Company Accounts
However, be wary not to keep on taking new debt or taking out a new loan for the sole purpose of improving your credit mix.
Takeaway
A credit score is one crucial factor in taking out a loan. However, it’s not the only factor. The way you manage your finances, your paying accountability, and your credibility as a borrower are critical.
A credit score is the representation of your financial health. If you’re a responsible borrower, even if you are starting a turnkey business, you will have a good or even an excellent credit score. If not, you’ll have a bad credit score. Therefore, be a better borrower and work on improving and maintaining a credit score to enjoy loads of favorable terms in the future.