Doing business of any kind with someone you don’t know is inherently risky. So how are banks and other lending institutions able to trust strangers applying for loans and lines of credit?
The answer is simple: they check the person’s credit score. In doing so, they get enough information to decide whether or not doing business with them is worth the risk.
But how do credit scores work? What determines someone’s credit score, how does that impact their ability to borrow money, and what can be done to improve one’s credit score if it’s currently low?
If you seek the answers to these questions, then keep reading. The following is what to know about credit scores and the two main types of scoring methods: FICO and VantageScore.
Credit score basics
FICO and VantageScore are analytics platforms that take a person’s recorded financial history and convert that information into a number. That number is your credit score. Banks and other entities use credit scores to determine the risk level associated with doing business with someone. The higher your credit score, the more likely it is you’ll be approved for a loan or line of credit. But if your credit score is low, lenders are unlikely to work with you without a cosigner, down payment, or some other form of financial reassurance.
Credit score range
FICO and VantageScore are nearly identical in terms of the scoring system used. Both platforms have a credit score range chart that starts at 300 and tops off at 850. However, the devil is in the details; the individual ranges indicating poor, fair, good, and excellent credit differs. For instance, 800-850 is considered excellent by FICO, whereas VantageScore considers 781 the starting point for excellent credit. 19 points might not seem like a big difference, but it is for those hovering between two different credit ratings.
Credit score use
As mentioned in the beginning, credit scores are mostly used by lending agencies and credit card companies when assessing someone’s financial ability to access loans and take on debt. But banks and credit card companies aren’t the only entities that use credit scores. Landlords often assess a person’s credit score prior to approving their apartment rental application. Automobile insurance companies also use credit scores to determine a person’s premium payments. If you’re applying for a job in which you handle large sums of money, the employer may run your credit score as well.
Credit score impact
It’s easy to see how one’s credit score impacts their life. It determines which financial instruments they have access to, which jobs they qualify for, and which types of housing they can obtain. Generally speaking, those with low credit scores pay more interest over time. They’re also expected to cough up more money for down payments and deposits. The unfortunate reality is poor credit makes life more expensive. But the good news is that credit scores are not fixed; they fluctuate over time. Therefore, it’s possible for those with low credit scores to improve them over time.
Credit score improvement
There are several ways in which those with poor FICO and VantageScore credit scores can boost their score and gain access to better financial options and instruments. Start by chipping away at existing debt – particularly any credit cards you have with exorbitant interest rates. The goal is to get your credit utilization ratio down to 30% or less. That means only one-third of your available credit is being used. You also want to pay bills on time to avoid being flagged for missed payments, which takes a big chunk out of your credit score if reported. Lastly, you want to dispute any erroneous information on your credit report.
Credit score protection
Once your FICO and VantageScore credit scores are up to where you want them to be – somewhere 700 or higher – it’s time to make sure it stays that way. Avoid maxing out credit cards, keep paying your bills on time, and monitor your financial activity for any signs of fraud or identity theft.
Credit scores are a way for banks, credit card companies, and other entities to accurately assess your financial ability and responsibility. FICO and VantageScore credit scores are the most commonly used credit scoring systems. With this in mind, it’s essential to ensure your FICO and VantageScore credit scores are where you want them to be.
Julie Steinbeck is a freelance writer from Florida. She enjoys covering topics related to business, finance, and travel.