If you want to get approved for a HUD loan or car loan early in your life, you’ll likely need to take out a loan. And it comes with a variety of requirements, including your down payment, proof of employment, income, debt-to-income ratio, and your credit score. Most of these are relatively easy and straightforward to get early in your life.
However, credit score may get confusing to build, especially for young people who don’t know much about it. Learn what a credit score is, what it means of your financial future, and how to build it as soon as you start working.
What Is a Credit Score?
Your credit score is a three-digit number between 300 and 850 that indicates how trustworthy you are to creditors. The higher it is, the better your chances are at repaying a loan from the perspective of your lender. Various companies measure credit scores, and they all have different ways of measuring it. The most popular comes from the Fair Isaac Corporation or FICO.
Your FICO score is determined by the following factors:
- Payment history — Payment history is the most significant factor, as it makes up about 35% of your score. That makes up the bills you’re currently paying and other loans you may be managing.
- Accounts owed — This determines how much money you owe compared to the amount of credit you have available. Accounts owed make up 30% of your score. The less debt you have compared to your available credit, the better.
- Credit history — This measures how long your credit accounts have been open and how long it’s been since you’ve used your accounts. Credit history makes up about 15% of your score. Longer credit histories often lead to a higher score.
- Credit mix — Credit mix is the combination of your different accounts. That includes your installment loans, mortgages, credit cards, and more. FICO uses a credit mix to determine how successful you are at maintaining multiple accounts. It makes up 10% of your score.
- New credit — This determines how many new accounts you’ve opened during a period. Banks see people who open a lot of new accounts in a short period as high-risk.
Credit Score Ranges and Their Impact
Creditors often look at your credit scores in ranges, including:
- 800 to 850 — Excellent
- 740 to 799 — Very Good
- 670 to 739 — Good
- 580 to 669 — Fair
- 300 to 579 — Poor
Credit plays a significant role in how lenders handle your loans. People in the fair range and below often get relegated to subprime. Subprime mortgages often get higher interest rates than traditional mortgages. These also come with shorter repayment schemes, and if the score is low enough, a co-signer as well. Lenders see people with low credit scores as high-risk borrowers, meaning that there’s a higher chance that they either pay back loans late or don’t pay them back at all.
Improve Your Credit Score
Your credit score is evaluated for every loan you take, whether it’s for the latest smartphone you’ve always wanted, a new credit card, or a brand new home. And if you’re going to get lower interest rates and more manageable payment schemes for them, you have to improve your credit score.
- Get a credit card — You can get a credit card on your own as soon as your turn 18. Your best options are to get a student card or a pre-approved credit card. Creditors often screen consumers from a list provided by credit bureaus. They usually send offers to qualified people via email or post. You could also apply for a card with a co-signer. Having a card alone won’t significantly improve your score. You need to use it frequently and responsibly. Don’t max them out, as your credit utilization is one of the most significant factors in your score.
- Pay your bills on-time and in-full — Your payment history makes for most of your credit score. You should always pay your bills on time. It’s better to pay in full, too, so you can avoid interest charges. Interest can pile up and make on-time payments more difficult for you.
- Inspect your transactions carefully — If you’re having trouble paying your bills despite your best efforts to manage them, you should review your credit card transactions and credit report. These will show if there were fraudulent transactions that involved your accounts. The better you are at managing your accounts, the better your credit score can be.
Your credit score plays a vital role in your long-term purchases. It shows how much trust banks should put on you. The more trust your lender has on your ability to manage your accounts, the lower the interest rates and monthly payments you’ll get. Use these suggestions to improve your score and get the best loans for your first big purchase.