One of the most common ways of financing yourself or your business is through loans or credit.
Credit is a great financial tool. Like any other tool, it can help you achieve your objectives when used correctly. However, it can have negative consequences when mismanaged. So, having healthy credit habits is essential.
In this article, we look at what is a credit score, what affects your score, and how to be a responsible borrower.
What is a Credit Score?
A credit score is a number between 300 and 900 given by credit bureaus to represent your creditworthiness. The number shows creditors and lenders your likelihood of paying back on time. The higher the number, the easier for you to get a loan.
Credit scores differ from one credit bureau to another and will grade you differently. According to Equifax*, the credit scoring model looks like this:
- Below 580 are considered poor borrowers and will face more challenging times getting credit
- 580 to 669 are graded fair and will find it challenging to get good credit terms
- 670 to 739 are considered reasonable and will have an easy time accessing good loans
- 740 to 799 are considered very good and will receive fairly good conditions
- and 800 and up are considered excellent and will get fantastic credit terms
So, what can make your credit bad or low?
What Affects your Credit Score?
Credit bureaus will usually look at the following when giving you a credit score.
- Payment history- Your payment history is the most important credit scoring factor. Credit bureaus will determine how often you paid your previous loans on time and when you missed payments. Continuous on-time loan payments increase your credit score.
- Current debt baggage- This is the number of loans and the amount you are yet to pay to your creditors and lenders. If you have a lot of loans, it could negatively affect your score.
- Length of credit history- The period you have been taking credit affects your credit score. This age includes the age of your oldest and newest accounts and the aggregate of the ages. Someone with old healthy credit accounts receives a higher credit score.
- Credit mix and type- The number of credit accounts and types you have affects your credit score. Having various accounts like a car loan, credit card, student loan, and mortgage shows how well you can handle various credit products.
- New Credit- The number of credit accounts you opened recently also affects your credit score. When you apply for credit, lenders will review your credit report (hard inquiry). This inquiry remains on your report and can hurt your credit score even if you don’t qualify. A high number of hard inquiries show an increased risk.
Now that we know what affects your credit eligibility let’s look at how you can be a good borrower and maintain high credit worthiness.
How to be a Responsible Borrower
Pay your Loan on Time
The most important part of being a responsible borrower is paying your loans before due dates. This reflects positively on your credit report and translates to a good credit score.
Understand the Purpose of your Loan
Understanding why you need a loan is crucial. It will help you develop a budget that will guide you to use the loan for the intended purpose. In addition, a budget will help you manage the funds well and avoid looking for more after mismanagement.
Have a Repayment Plan Ready
You should only borrow an amount you know you can pay back in time. Therefore, it is important to devise a plan for the number of installments and the amount you can manage per installment. In addition, it will help you look for loan terms that fall within your range. On-time payments increase your creditworthiness.
Keep a Clean Credit Score
Multiple credit applications result in many hard inquiries. These hard inquiries will dent your credit report, making lenders avoid you. Also, ensure you pay your loans on time.
Grow a Healthy Borrowing Culture
Credits are part of life, and they help in hard times. When used correctly, they can add value, but mismanagement is detrimental. Ensure you take necessary loans for specific reasons and plan to pay them back in time. A good credit culture translates to healthy financial management!
*Equifax Inc. is an American multinational consumer credit reporting agency headquartered in Atlanta, Georgia and is one of the three largest consumer credit reporting agencies, along with Experian and TransUnion.