What You Need to Know About Building Credit
Credit is important for several reasons. It plays a role in our overall financial picture and touches many aspects of our lives including our ability to make large purchases, qualify for rentals, get certain jobs, and the amount of interest and fees we’ll be charged when borrowing.
Understanding how credit works when building a good report and score for the first time is key. Here’s some info that can help you get started and on the right path to a healthy credit report and score.
What is Credit, exactly?
The credit we’ll be talking about refers to your borrowing and repayment history. Think of it as your “financial reputation”. Your payment history and balances along with a few other factors (that we’ll discuss below) are compiled by the credit bureaus and scoring models to create a report. Lenders use these reports and scores to gauge the likelihood that you’ll repay the loan and decide if they will extend financing to you.
Do I really need Credit?
YES! As stated earlier, credit touches many aspects of our lives and plays a huge role in our financial foundation. It grants you the ability to borrow money from lenders to make a purchase and is an asset that can be leveraged to build future wealth.
How does Credit Work?
Lenders, like banks, credit unions, and credit card companies grant loans or lines of credit to consumers (aka borrowers) to make purchases. Lenders report your payment history to one or all of the three major credit reporting agencies – Equifax, Experian, and TransUnion (known as the Big Three).
Those three use that information to compile your credit report(s). Each bureau sends those reports to the two credit scoring companies in the country – FICO (Fair Isaac Corporation) and VantageScore, who generate your score(s).
Credit Scores
As mentioned above, there are two credit scoring models used in the country: FICO and Vantage.
FICO, created by the Fair Isaac Corporation in the late 1980s, is used by 90% of lenders in the country. FICO scores range from 300-850 and generates scores based on the following factors:
- Payment History: 35%
- Amounts Owed (utilization or balances): 30%
- Length of Credit History (age): 15%
- Credit Mix (combination of loans and revolving credit lines like credit cards): 10%
FICO reports having 16 different scoring models or versions used by lenders and other authorized users like landlords, insurance and utility companies, and employers. Learn more about FICO Scores here.
The VantageScore was created in 2006 as a joint venture between Equifax, Experian, and TransUnion. Vantage has released five credit scoring models with VantageScore 3.0 and VantageScore 4.0 being the most used. VantageScores range from 300-850 and are calculated a little differently than FICO, using the six categories below, which each carry a different level of influence on your score:
- Payment History: extremely influential
- Credit Utilization: highly influential
- Credit age & mix: highly influential,
- Amounts owed: moderately influential
- Recent behavior: less influential
- Available credit: less influential.
Although it’s not as common as FICO, Vantage reports being used by 3400 lenders and organizations, including 8 of the top 10 banks and credit card issuers. Learn more about VantageScores here.
How do I check my Credit Reports & Scores?
The three bureaus have worked together to make it easy for consumers to go to one place to access all their reports by creating www.annualcreditreport.com. Federal law allows consumers to receive a free report from each of the major credit bureaus at least once per year, however, they have recently made free reports available weekly.
Scores must be checked separately by going directly to myfico.com and VantageScore Both have free and paid options.
It’s important to monitor your reports (all three) and scores. The credit bureaus rely on lenders, just as the scoring models depend on the bureaus, to report information used to generate reports and scores. This means that each report is unique, can be different, and should be checked for accuracy regularly.
Want more tips on building a healthy credit report and score? Read our blog, Building Credit for the First Time.
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