Your credit score is a three-digit number that represents the overall health of your credit history, estimating your creditworthiness with a number. But are credit scores important if you don’t need to apply for credit anytime soon? And how important is a credit score even then?
Here’s everything you need to know about the importance of your credit score and the benefits of building and maintaining good credit.
What Is a Credit Report and a Credit Score?
A credit report is a comprehensive catalog of your dealings with credit. In addition to providing a list of all of your current and many past credit accounts, it also shows balances, monthly payment amounts, payment history, account status, and more.
If you file bankruptcy or get foreclosed on, that information will also show up on your credit reports. You have three credit reports, one from each of the national credit reporting agencies, Experian, Equifax, and TransUnion. The information found in each report can differ from the others, primarily because not all creditors report to all three bureaus or even use all three of your credit reports in lending decisions.
But what is a credit score, and why is it important? Your credit score is a numerical representation of the information found on your credit report. Credit scoring companies like FICO and VantageScore take the data listed on your credit report and give it a rating based on how they assess credit risk.
The higher your credit score, the better your chances of getting approved for credit when you need it and with more favorable terms.
What Comprises Your Credit Score?
There are a handful of factors that go into determining your credit score, but they can vary depending on the credit scoring model that’s being used. The two most popular scoring models are FICO and VantageScore, but FICO is more widely used in lending decisions, so it’s more important.
And while each provides a basic list of what goes into calculating your score, it’s important to note that each company has updated their scoring models several times over the years.
For example, the FICO 9 score doesn’t ding you for paid collection accounts, but all previous FICO models do. So if you have a collection account you paid off, and one lender uses the FICO 9 model, and another uses the FICO 8 model, you could get two different scores.
That said, here’s how the two top credit scoring models break down.
FICO Rating
FICO considers five primary factors when calculating your score. While it lists a percentage next to each one, indicating how much it influences the calculation, they aren’t hard-and-fast rules:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- Credit mix (10%)
- New credit (10%)
VantageScore Rating
Instead of assigning weight percentages to each factor, VantageScore simply shares how influential they are:
- Total credit usage, balance, and available credit – extremely influential
- Credit mix and experience – highly influential
- Payment history – moderately influential
- Age of credit history – less influential
- New accounts opened – less influential
The Importance of Your Credit Score
The credit system is far from perfect, but that doesn’t change the fact that your credit score is extremely important to your financial well-being.
The Areas of Your Life Where Your Credit Is Important
The most obvious area of your financial life where having good credit is crucial is in lending. In an ideal world, people would be able to pay cash for everything they want and need. But the reality is that to buy a house or a car, most consumers need financing.
Additionally, some people use credit cards, personal loans, and other forms of credit to cover emergencies and other expenses. Even many forms of business financing require a personal guarantee, so having good credit is essential.
Beyond the world of credit, though, having good credit is also important when you buy an insurance policy. In most states, auto and homeowners insurance companies use what’s called a credit-based insurance score to help determine your premiums. This score is different from your traditional credit score, but not by much.
Finally, if you’re thinking of applying for an apartment lease or a job in financial services or even with a government agency, the landlord or employer may review your credit report — though not your credit score — to help determine whether to approve your lease application or hire you for the job.
The Benefits of Keeping a High Credit Rating
Maintaining a high credit score opens up a lot of opportunities that may not be available for people with poor credit or limited credit history.
For example, if you’re applying for an auto loan, mortgage, or another type of installment loan, having a high credit score not only improves your odds of getting approved but also helps lower your interest rate. Lenders typically charge higher rates to people with lower credit scores because the risk of default is higher and charging more helps mitigate that risk.
Also, while credit card interest rates are generally high across the board, the cards with the best rewards and benefits tend to be reserved for people with good or excellent credit.
When it comes to insurance, things get a little trickier. In a handful of states, the practice of using credit to calculate rates is prohibited. And in most of the states that do allow it, insurers aren’t allowed to use your credit rating as the sole reason to charge a higher premium.
But if there’s even one other reason for raising your premium, a bad credit score could hike it even more.
Finally, as you might have already guessed, having a pristine credit report will give you a much higher chance of getting approved for a lease or getting hired in a job that requires a credit check.
How to Improve or Maintain A Good Credit Score
It isn’t easy to give pointed advice about how to improve credit because every credit report is different. However, here are some of the best things you can do:
- Check your credit score to see where you stand.
- Review your credit reports for potential issues you need to address.
- If you find inaccurate information on your credit reports, dispute it.
- Always pay your bills on time and in full.
- Avoid carrying a high credit card balance relative to your credit limit.
- Keep old credit card accounts open, even if you’re not using them.
- Correct issues like late payments immediately.
- Avoid applying for credit unless you absolutely need it.
- Monitor your credit regularly to spot and address potential problems quickly.
- Use a product like Experian Boost to add other on-time payments to your credit report, such as utility, phone, and streaming services.
FAQs About the Importance of Your Credit Score
Your credit score is integral in many areas of your financial life, including borrowing, buying insurance, leasing, and sometimes even when applying for a job.
It can depend on the scoring model that’s being used. But with the most popular score, the FICO score, the most influential factors are your payment history and how much you owe. With the second category, the most important thing is how much available credit you have on your credit cards — the more, the better.
There’s no way to fix credit overnight. But some fixes can make a difference faster than others. For example, disputing inaccurate information on your credit report can improve your credit as soon as it’s removed by the credit bureaus.
Also, if you have a family member add you as an authorized user on their credit card, your score can improve quickly because the account’s entire history will be added to your credit report. Finally, paying down a credit card balance quickly could boost your credit score as soon as the new balance gets reported to the credit bureaus.
Each creditor has its way of determining what qualifies as excellent credit. But in general, if your credit score is in the mid-700s or higher, you have excellent credit.
The same concept applies as with excellent credit, but in most cases, a bad credit score is a score that’s below 580.
