What is credit? How does it work? How can you improve your credit score?
What is credit?
Credit is "the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future."
Someone that has good credit is credible. We believe that they will stand by their word. In the courtroom an attorney that is trying to establish his or her case will bring forth a credible witness to testify. We may believe the testimony of this witness because (1) they have a history of being honest (2) they have no reason to lie.
The same is true regarding ones credit. There are many factors that go into a person's credit score, but the two primary factors are (1) length of time an account has been established, and (2) the proportion of loan balances to loan amounts. In other words, do you have a history of being honest and does it appear as if something sketchy might be going on - do you have a reason to lie.
How does it work?
The most common credit scoring system is the FICO score, a score used by the major credit agencies to rate your creditworthiness. Your FICO score will be between 300 and 850 with a higher score being better. When it comes to your credit, lenders may sometimes refer to it in terms of Credit Level or Credit Quality such as Poor, Fair/Average, Good or Excellent with each category referring to a range of FICO scores. (1)
Your score will determine whether a lender approves a loan, and what types of loans to offer.
How can you improve your credit score?
Pay your bills on time. Delinquent payments and collections can have a major negative impact on a credit score.
Keep balances low on credit cards and other “revolving credit.” High outstanding debt can affect a credit score.
Apply for and open new credit accounts only as needed. Don’t open accounts just to have a better credit mix. It probably won’t improve your credit score.
Pay off debt rather than moving it around. Also, don’t close unused cards as a short-term strategy to improve your credit score. Owing the same amount but having fewer open accounts may lower your credit score.(2)
Would you loan yourself money? If you answer is no, then you should reassess your finances.