If you are an entrepreneur or self-employed, then you will have to make a lot of financial decisions on your own. If you aren’t used to this sort of thing then you end up being swamped with various confusing terms you don’t understand. One of these terms you will run into is the credit score. In this article, we will go over everything that you need to know about credit score, what it is, how it works, and why it is important to your financial future.
What is a credit score?
To put it simply credit score is a numerical value assigned to you that is used by lenders to determine whether you will be able to repay loans. Credit scores are 3 digit numbers, and the higher the number, the better your credit score is. Whenever you apply for a loan, such as a mortgage, your credit score is one of the details that will be taken into consideration.
It is used to measure how likely you are to repay a loan. The more likely you are to be able to repay, the more likely you are to receive a loan.
What affects your credit score?
Your credit score is a complex thing and is affected by a variety of factors. These factors include:
- Your payment history: This includes payments like credit card payments and other loan repayments. If you consistently pay your loans back on time in full then your payment history will be positive, and your credit score will improve. This proves to your lenders that you can consistently make repayments without hassle, which makes their job much easier.
- Any outstanding debt: The more money that you owe others, the less money you have for yourself. Being bogged down by repayments towards other sources makes you less likely to be able to repay anyone else you borrow from. So as long as you have outstanding debts, your credit score will be negatively impacted.
- Credit history: This includes a lot of factors regarding credit. Opening credit accounts, having a lot of credit accounts, and the amount of time you have had your credit accounts all affect your credit history and score. Be careful when applying for new credit because you risk damaging your credit score.
- Types of credit you have: Someone with many different types of credit open will have a much worse credit score than if they didn’t take those loans. Different credit types include things like mortgages, multiple credit cards, and loans for multiple different areas.
- Hard inquiries: When an inquiry is made on your credit report it can either be a hard or soft inquiry. Hard inquiries are when the company you are applying for credit from performs the inquiry, and soft inquiries are when you perform the inquiry yourself. Only hard inquiries affect your credit score because they are a part of a credit application.
What doesn’t affect your credit score?
Credit score might seem quite complex and worrying, but it’s not as bad as many people imagine. There are a number of financial factors that are commonly perceived as affecting your credit score despite the fact that they do not. Trying to improve in these areas is a waste of time if your only goal is to improve your credit score. These factors include:
- Your income: This might seem perplexing, but it makes a lot of sense if you think about it. Your credit report is based on your borrowing history, not how much money you have. Since your income doesn’t directly affect your borrowing history, it doesn’t affect your credit score.
- Your savings: This falls under the same category as your income. Your savings are indicative of your wealth, not your borrowing. So, this also doesn’t affect your credit score.
- General payments: General payments and outgoings do not affect your credit score. Various payments such as gas and electric bills, rent payments, and tv license payments do not appear on your credit report. In some cases, this is starting to change, companies like British Gas are already reporting data to various credit agencies. It’s possible that other companies may follow suit in the future.
- Using a debit card: When you use a credit card you are borrowing money on credit. However, with a debit card or prepaid card, you are spending your own money which then doesn’t appear on your credit report.
- Soft inquiries: A soft inquiry is when you check your own credit report. Unlike a hard inquiry, this isn’t part of a credit application, which means that it does not appear on your credit report and doesn’t affect your credit score.
Why credit score is important?
A credit score is very important in the modern world for a number of reasons. A lot of financial services will be at least somewhat affected by your credit score. These include:
- Borrowing money: Whether it’s from a bank or another lender, you will need to show your credit score to them so that they can assess you. Before they make their decision of whether to lend you the money, they need to assess if you’ll be able to repay the loan. The easiest way for them to do this is to check your credit score. Sometimes you may be able to get a loan without the lender checking your credit report, but these will usually be a lot more expensive.
- Some areas of employment: This varies from job role to job role so this may not come up for a lot of people. This mostly applies to jobs that involve handling a lot of money such as a bank worker, although other jobs may also ask for a credit inspection.
- Renting: Whether you’re renting an apartment, a car, or anything else the lender will often run a credit check on you. Depending on your current credit rating you may have to pay a higher deposit, or if you are very unfortunate you may be denied the loan entirely.
How to improve your credit score?
As we know, your credit score is very important for a wide variety of things. To best the best deals and be able to successfully get the loans that you need for your various endeavors, you want to have a great credit score. There are a lot of ways for you to improve your credit score that are simple and effective. These include:
- Paying your bills on time: One way that credit scores can get damaged is by missing bill payments. Paying your insurance bills, gas, electric, tv license, etc on time is crucial. If you miss some payments you can repair the damage by paying your bills on time, it may take some time, but you will inevitably repair any damage dealt.
- Check for mistakes on your credit reports: This will be easier if you have been keeping track of your various expenses and earnings (such as receipts and bank statements). If you keep these records and find inconsistencies on your credit reports, you can use these documents to challenge those inaccuracies. If you successfully fix these inaccuracies, then your credit reports will improve and so will your score.
- Limit your credit applications: If you apply for multiple sources of credit within a short period of time, you can damage your credit score. Make sure to limit yourself so that you don’t need excessive credit. Budget yourself to use your money more efficiently.
- Pay off your debts: Any outstanding debts you have do negatively affect your credit score. Paying off your debts is the first step to repairing the damage to your credit score. After your debts are paid off just keep paying for everything on time and avoid returning to debt.