Financial Literacy 101: Credit Scores

Financial Literacy 101: Credit Scores

Jan, 3rd 2017

It’s that time again! Welcome back to Insedia’s “back to basics” series. Throughout this series, we’ll be examining some of the most important fundamentals in financial literacy. These principles will help guide you in how to make better financial decisions, no matter where you are in your life. So far, we’ve looked at the importance of budgeting, the effects of debt, and how to start saving money. Today, we’re going to look at “credit” and credit scores, which are essential to your financial future.

What is credit? There are a few definitions that refer to different things, but we’re going to focus on “credit” as it directly relates to credit scores. Put simply, credit is a publicly acknowledged and demonstrated ability for a consumer to pay back debts. Think of it as your financial reputation; you’ll want to protect it and improve it as much as you can, as early as you can.

How Credit Scores Work

Your credit score is calculated and kept by FICO, a company exclusively focused on credit rating services. It uses a range of 300 to 850, based on a number of factors, the most important being:

  • How much you owe. If you owe lots of money to lots of people, your credit score will go down. The lower your balance, the better.
  • Payment history. Having no debt isn’t enough to have a good credit score—you also need a history of on-time payments. Missed or late payments will hurt you.
  • How long you’ve held credit. The longer you’ve been paying, the higher your score will be—this will work against you as a young adult.
  • Credit mix. The types of debt you hold and number of accounts you have open will factor into your score.
  • New credit. Securing new lines of credit and accumulating new debt can be a sign of volatility, and may work against you.

Below 550 is considered “bad,” with 550-649 being “poor,” 650-699 being “fair,” 700-749 being “good,” and 750 and up being “excellent.”

Why Credit Scores Are Important

It may seem like credit scores are some arbitrary number, but it can have a massive effect on your future. These are just some of the areas that credit scores can impact:

  • New loans. Banks and lenders look at your credit score before determining what types of loans you qualify for.
  • Renting. Many landlords will check your credit score before allowing you to rent.
  • Working. Some workplaces will check your credit score before hiring you.

How to Earn a Better Credit Score

If your credit score is low or non-existent, how can you improve it? Your first job is to avoid seeking new accounts (unless you have zero to start with) and start paying down whatever debts you can (see the first two parts of our series for further advice here). Beyond that, your best friend is going to be time; make your payments on time, pay your debts down, and over time, your credit score will gradually improve. Unfortunately, since history is such a major factor in your credit score, there’s no fast way to do this.

In the meantime, if you’re looking to learn more about financial literacy and how to get your finances back on the right track, be sure to join the Insedia community!

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