Your Credit Score Is Important, But Why?
When it comes to your credit score, you need to keep score. After all, lenders certainly will. If you need to make a major purchase like a home or a car, odds are that you'll have to get a mortgage or take out a car loan. Lenders will examine your credit score to determine how credit-worthy you are: if your credit score is too low, you'll likely be rejected for that loan.
What's a Credit Score?
A credit score essentially indicates how good you've been about paying back your existing loans and managing your debt. Fair Isaac Corp. developed the most common FICO credit score, which is used by the three major credit bureaus: Equifax, TransUnion and Experian. FICO scores can theoretically range anywhere from 250 through 900, but for practical purposes they tend to range from 300 to 850. Basically, the higher your score, the more credit-worthy you will appear to lenders. (For more, see: What's On a Consumer Credit Report?)
There are times when you need to make a purchase that you're unable to fully finance, whether it's a major home renovation or a new car. When you need to take out a consumer loan, your credit score will play a huge role in a) whether a lender will agree to provide you the financing and b) the type of financing available. For example, the higher your credit score, the greater your ability to negotiate with a lender for a lower interest rate on your mortgage or car loan. Thus a debtor with a favorable credit score could reap thousands of dollars in savings by nailing down a less onerous interest rate.
A good credit score isn’t only important for home buying. Even if you're only planning to rent a house or apartment, you should expect your prospective landlord to look up your score to determine whether you'll be a good bet as a tenant. A below-average score could lead the landlord to determine you could be unreliable in making monthly payments, and so aren't worth the risk. (Further reading: The Landlord-Tenant Relationship.)
A growing number of employers will examine potential hires' credit reports as part of the job interview process, arguing that a credit report provides a good snapshot of an employee's ability to keep up with commitments. That said, employers who engage in this practice must get your permission to access your credit report.
In such industries as financial services, where employees handle money accounts or have access to sensitive financial information, employers often use a credit report to get a sense of a potential employee’s financial integrity. (See: Why Bad Credit Is Bad For Financial Careers.) It's not just finance, though. Any industry whose employees have access to sensitive information, such as defense contracting and chemical manufacturing, will likely consider a potential employee's credit report as providing critical information as to their character.
Note that while a credit report for employment purposes is based on your credit activity and history (the same factors that go into your credit score), the credit bureaus don’t provide employers with your actual numerical score. So if you're able to better manage the factors affecting your credit history, such as keeping up with payments and paying down debt, you can help reduce the chances of being screened out by potential employers.
Getting a Higher Credit Score
The biggest chunk of your FICO credit score, 35%, is based on your payment history. This assesses whether you've paid your bills on time in the past. Another 30% of the score reflects the amounts that you owe on existing credit accounts. So if you've used up a large percentage of the credit lines currently available to you, this could lower your score and lead lenders to believe you've taken on too much debt and could miss a payment in the future.
Another important input is the length of your credit history. If you've been using credit accounts for a long time and have handled yourself responsibly, this input (making up 15% of your FICO score) will likely increase your score. The irony is that someone who has never used credit is thus penalized for living debt-free. Variety is another factor. The mix of credit accounts that you currently have--such as retail accounts, credit card accounts and mortgage loans--makes up another 10% of your FICO score. The more variety, the better, though this input is less important if you have a long credit history. And the last 10% of your FICO score addresses how fresh your debt loads are. If you've opened many new accounts in a brief period of time, this could hurt your score.
The Bottom Line
Your credit score is an essential number that you need to know before you buy a car, apply for a job or get an apartment. If you've managed your credit responsibly and pay your bills on time, your score will likely be positive. On the other hand, a low score can prove to be a serious burden affecting many aspects of your life. You need to know if you have a low score so that you can get to work on raising the number.