We all know that we have a credit score, and that your credit score is important to determining how lenders treat you when shopping for financial products. But many of us are hazy on what precisely it is and why it can have such an impact on your financial well-being. Here’s an overview of what a credit score is, how it’s determined, and how you can get a better one.
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Your Credit Score, And How It’s Determined
So, what precisely is a credit score? Essentially, it’s a tool to assess risk, where how likely you are to pay back your loan is shown by a three digital number on a report, generally paired with your credit history. That’s part of the reason your credit score is so commonplace; assessment of risk is so simple for lenders, they can use it to make fast judgments or set specific tolerances for specific financial products.
One of the most common misconceptions about your credit score is that it’s determined by a governmental body or by the banks. Neither is true; your credit score is calculated by private credit bureaus, using a proprietary method of calculating your score.
You may have heard your credit score is also called a FICO score. FICO is short for Fair Isaac Corporation, the company that created the credit score algorithm. The FICO algorithm is constantly being fine-tuned and tested, attempting to improve it and make it more precise. Credit bureaus, meanwhile, will generally incorporate your score into a more comprehensive report, which is what’s generated when you apply for auto financing.
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Changing Your Credit Score
Essentially, everything you do, financially, is tracked by credit bureaus and has some form of impact on your credit score. The more obvious examples of actions that can change your credit score include whether or not you pay your bills on time, whether or not you pay more than the minimum payment on your credit cards, how much credit can be extended to you at any given time, how much of it you’re currently using. Making your payments on time, paying more than the minimum, and other positive steps will raise your credit score; missing payments, not paying the full bill, and otherwise being unable to meet your financial obligations will lower your score.
As you may have guessed, the lower the score, the more of a risk you are and the more you’ll have to pay in interest and other costs. You may also not be able to borrow from some lenders, depending on your score. So, especially if you’re still finding your feet after a setback, how can you improve your score?
The simplest is the most obvious; pay your bills, and try to pay more than the minimum. The better your finances are, the more your score will improve. You should also request your credit report; under the law, credit bureaus are required to provide it to you once a year. Check it closely for errors; even small mistakes can improve your score when corrected.
The more you clean up your credit score, the better your lending chances will be. So get your report, and make sure your score is spotless.
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