What is credit?
Credit is the ability to borrow money or access goods or services knowing that you will pay for them later. It increases your financial power by helping you buy the things you need now even if you don’t have the money to pay for them now.
One factor that can determine your ability to borrow money in the future is how you have used credit in the past.
Decoding credit scores
Your credit score is your reputation as a borrower and gives lenders an idea of how likely you are to repay borrowed money as promised. Lenders use credit scores when deciding whether or not to lend money. A good credit score can make it easier to get loans, open new cards, and get low interest rates.
Credit scores are determined by your credit report, which is a detailed history of your past use of credit. There are several scoring models, but the best known is the FICO score, which can range from 300 to 850. The higher your score, the more likely you are to be able to borrow on favorable terms.
Factors that affect your credit score
- 35% payment history. Whether or not you have paid lenders on time in the past is the most important factor that affects your score.
- 30% of the sums due. Using only a small portion of your credit limit usually improves your score, while maxing out or holding a balance on many cards can hurt your score.
- 15% length of credit history. A longer credit history is generally better because it gives lenders more information about the type of borrower you are.
- 10% mixed credit. Having handled different types of credit, such as credit cards and a mortgage, can help you get your score.
- 10% new credit. Applying for lots of new credit cards or loans usually hurts your score.
Why good credit is so important
Establishing a good credit history can have a huge impact on your life. Lenders can use your credit history to determine whether or not to lend you money and at what rate. If you’re applying for a mortgage, a better interest rate could lower your monthly payments and reduce the total interest you pay over the term of your loan.
Your credit history can also affect non-financial aspects of your life. Landlords can use your credit score to decide whether or not to rent to you. Insurance companies sometimes use scores in calculating premiums. In some cases, employers may consider your credit history when considering job offers.
With good credit, you have one less thing to worry about.
Tips to increase your credit score
- Always pay your bills on time.
- Try to pay balances in full each month. If you can’t, make at least the minimum payment.
- Do not use more than 30% of your available credit on a given card or line of credit (eg $300 on a card with a credit limit of $1,000).
- Avoid unnecessary credit inquiries and apply for new credit cards only when you need them.
- Don’t close old cards, even if you don’t use them anymore, because the longer history of old cards can help your score.
- Check your credit score for changes and your credit report for errors at least once a year.
View the original fact sheet Give yourself credit.
To learn how to build credit, read New Ways to Improve Your Credit Score.
Main contributor: Editorial UBS
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Revision Code: IS2202244