What is Credit?
Credit is your capacity to successfully make your payments for your loans and lines of credit. It is essentially your ability to make all of your payments on time and in full. It is essential and can ultimately dictate how you are able to borrow money and how much you can borrow. Your credit is always changing and can become stronger or weaker depending on how you handle your debts. Your ability to manage your debts is constantly being edited and processed by credit bureaus that compile information about you into “credit reports” and “credit scores.” In turn, these are analyzed by your potential lenders so they can make a decision on whether to lend to you or not. This guide will delve into what exactly credit scores and reports are, why they are important, and how you can improve them.
What is a Credit Report?
A credit report is a document that includes everything there is to know about one’s credit. The three main credit bureaus, TransUnion, Equifax, and Experian, collect credit information from lenders, like a credit card company or a bank. Lenders report information such as the current account balance, and whether there have been any late payments or not. The credit bureaus compile the information from your lenders from the past 7 years into a credit report.
The main body of your credit report consists of something called “tradelines.” Each tradeline is a loan or credit account currently in use or has since been closed. These tradelines provide information such as the type of account you opened, how much you paid each month, and how successfully you made payments. The information within these tradelines is the most important information for your lenders, as it goes into great detail about your ability to take on and manage debt. The information in these tradelines includes:
- Lender’s Name and Address: Each tradeline tells exactly where you took debt out from. This way, if your next lender has any questions about you they can reach out to your past lenders to get some specific information about you.
- Type of Account: The specific type of credit or loan you acquired is listed here. This could be anything from your credit card or auto loan, to your mortgage or student loan.
- Partial Account Number: Account numbers are displayed on tradelines to verify the account, but only part of the account number is shown in order to limit fraud if someone were able to get a hold of your report. Note: You can call the credit bureau to get your full account number or you can receive it by paper.
- Date the Account Was Opened: This date is shown to give more context to a lender. A tradeline from 25 years ago is not as informative as your repaying ability than one from 2 years ago.
- Date the Account Was Closed: Likewise, this date is shown so the lender can see if the account is still ongoing or not.
- Current Payment Status: Current status refers to the standing of the loan or credit account. If you have an outstanding late payment, your current status will show this. If you are all caught up on your payments, your current status will be in good standing. Your next lender could look at your current loans to see how well you are performing with them.
- Current Balance: The amount you still have to pay on your specific account will show up. Your lender might look at this to see how much other debt you have. If you have multiple trendlines with large current balances, your next lender might be skeptical that you will be focused on paying their debt back first instead of the other balances you have.
- Original Loan Amount or Credit Limit: This shows exactly how much debt you took on initially. If your tradeline shows you successfully paid off a large loan, your lender will be more comfortable lending you more money.
- Monthly Payment: Your monthly payments show your lender how much you are typically paying in a single month.
- Recent Balance (credit cards only): If the tradeline is for a credit card, your current balance will be shown on that credit card.
- Payment History: The record of your payments you’ve made for the tradeline will be shown. Both your successful and missed payments will both be shown here.
Your credit report will likely be viewed by any lender that you are looking to borrow money from. The lenders will want to know that they can trust you to repay them their money. The best way they can do this is by digging into the tradelines on your credit report to see how capable you are of repaying your debts. Credit reports are full of information for both you and your lenders and are an integral part of the loan process.
All of the information on your credit reports is condensed into a 3-digit number called your “credit score.” Let’s look into what exactly this is.
What is a Credit Score?
A credit score is a number credit bureaus assign to you that represents your creditworthiness. All of the information from your credit report is compressed into this number. Lenders, insurance agencies, employers, or anyone else who may want to see your creditworthiness can use this simple number instead of having to comb through your entire credit report.
The most commonly used credit score is called a FICO credit score (“Fair Isaac Corporation”). This is used by most of the credit bureaus and nearly 90% of lenders use this to help make their decisions on who to lend to and how much to lend. This number makes it easy for lenders to quickly interpret your overall risk when it comes to you paying back your debts or credit cards. If you have a lower score, lenders will see you as a riskier investment and will be more hesitant to loan you money or have a higher credit limit on your credit card. The FICO credit score ranges from 300-850, with 850 being the best score you can get. If you struggle to pay your debts off, your score will be lower and vice versa.
Another commonly used credit scoring tool is called VantageScore. VantageScore was created by the three credit bureaus. Just like FICO, Vantage score ranges from 300-850. It is actually very similar to FICO but uses slightly different criteria to come up with your credit score. It uses payment history, credit mix and age, credit utilization, balances, recent credit applications, and available credit, all to come up with your VantageScore.
Since so many lenders use your FICO and VantageScore credit scores, it is important that you pay great attention to it. Having a good credit score can save you a lot of trouble and can make your life much easier when it comes to getting loans and credit cards. It’s necessary that you understand what exactly makes up this score so you can work to improve on these aspects.
What Makes Up Your FICO Credit Score?
With every loan or credit account you open, lenders are constantly giving information about you to the credit bureaus. Most lenders report things such as whether your payment was made on time or the outstanding balance on your account. Lenders aren’t obligated to say anything to these bureaus. However, many of them do report to the bureaus to incentivize you to pay your debts. They report successful payments that boost your score to encourage you to pay on time. Likewise, they will also report unsuccessful payments that lower your score to incentivize you not to miss your payments.
Every report your lenders make to the credit bureaus impacts your credit score in some way. There are 5 major components that make up your FICO credit score:
- Payment History (35%): Your payment history has the biggest weight on your credit score. Your payment history is simply the record of your past payments from any loan account or line of credit from the past 7 to 10 years. Above all, lenders want to see concrete evidence of whether you can be trusted to pay back your debts. Any payment that’s been reported by your lender will be factored into here. Because this is so heavily weighted, it is extremely important to pay attention to if you want your credit score to be good. While consistently paying can bolster your score, missing payments can be devastating.
- Credit Utilization (30%): Credit utilization is how much of your credit line you use a month. Your credit utilization ratio is the percentage of this credit usage. If you are given $1,000 a month to use with your credit card and you use $800 of it, your credit utilization ratio is 80%. Credit utilization can be tricky. You are given credit with the implication that you’ll use it, but lenders don’t want to see you use too much of it. They want to see that while you have credit, you aren’t using every last cent of it and burdening yourself with heavy interest and principal payments. Lenders and credit bureaus want to see your credit utilization ratio be at 30% a month or below. Using any more credit than this can actually hurt your score.
- Length of Credit History (15%): While the length of your credit history is not as important as payment history and credit utilization, it still matters. The longer you have had your credit accounts the better. If you’ve successfully been making payments for 10 years, your length of credit history looks much better to a lender than someone who has only had credit for 1 year. Any credit history that is 7 years or more is good for your score. Consistency is key for lenders!
- Credit Mix (10%): Your credit mix is made up of the different types of debt that you have taken on. Lenders want to see this mix be as diverse as possible. For example, if your credit mix only consists of credit cards, an auto loan lender might see this as a red flag, since you have not had any experience with any type of loan.
- New Credit (10%): Any recent loan or credit accounts you’ve opened will impact your credit score. It’s better for your credit score if you don’t have many recent accounts opened. If you’ve opened many accounts recently, lenders might see this as a sign of desperation from you and that you might be opening new accounts to pay for older ones. Likewise, if you have multiple active accounts, new lenders will be skeptical that you will be focused on paying back their money instead of the others. Keep in mind that everytime you seek new credit though, you get an inquiry on your credit score. A hard inquiry is an inquiry you get when seeking new loans or lines of your credit. These can lower your score anywhere from 5-10 points, so make sure you have about less than 5 in any 6 month span. Conversely, soft inquiries do not come with seeking new credit and are usually done by employers. These do not affect your score.
How Can I Check My Credit Score?
Checking your credit score is extremely easy. The three main credit bureaus, Experian, Equifax, and TransUnion, all provide credit scores. Once a year, you can see your credit score for free from each of these companies. In total, you can view your credit score 3 times a year for free.
If you need to check your credit score more than 3 times a year, you can still check it. After your 3 free checks, you can pay an additional cost to these three credit bureaus to see your score again. Being on top of your credit score is important. If you are struggling to keep a good credit score, checking more than 3 times a year could be beneficial to you and you should consider paying for additional credit score checks. You can also check your scores through services such as the Credit Karma app or Credit Sesame, oftentimes for free.
Checking your credit score is extremely important. For one, you want to be able to see your creditworthiness to know if you need to make changes. If your credit score is low, you know you need to make changes to improve it. Seeing your credit report and knowing exactly what has been lowering your score is extremely beneficial. Likewise, if you are good about making your payments, you can check your credit score to see if your lender has been reporting your successful payments to the credit bureaus. If they haven’t, you will be able to see your credit report and then ask your lender to start reporting your good payments. Overall, checking your credit score and credit report periodically is not convenient; it’s very important. Make use of these 3 free checks every year to ensure you are on the right track to good creditworthiness.
What’s a Good Credit Score?
A good credit score entails that you are less of a risky investment for a lender. While it varies from lender to lender, a good credit score starts from about 680-740. Statistically, about 8% of lenders in this credit score range default on their payments. This is a relatively low percentage and those with this credit score are seen as a reasonably safe borrower. With a credit score in this range, you are unlikely to be denied on most of your loan and credit requests. However, you will usually get average loan terms compared to those with higher credit scores such as the 800 range.
What’s a Bad Score?
A bad score is generally anything that is under 680. If you fall under this benchmark, your credit score is known as “subprime” and you are thrown into a “subprime lender” category. You are seen as a riskier investment as a subprime lender and you will have a harder time getting access to the loans you want with the rates you want as well.
Why Is My Credit Score Important?
You now know what your credit score is, what affects it, and how you can view it, but why is it even important in the first place? Why is a 3 digit number worth always checking on and worrying about?
Your credit score is one of the most important aspects to getting a loan or a new line of credit. Your credit score can determine whether a lender wants to give you money or not. If you are in a dire situation and are in need of some cash, having a good credit score is extremely important. If you have a lower score, your lender will be less likely to loan to you and you could be without your much needed funds.
Fortunately, there are many lenders that still loan to those with a poor credit score, like Possible, where we offer the best alternative to traditional payday loans and installment loans to customers with poor or no credit history. On the flip side, most lenders that offer loans and credit to these customers oftentimes offer very unfavorable terms such as single payment, high APRs, and late penalties. Borrowers with low scores are seen as riskier, as loan defaults and low credit scores are closely correlated. To help recoup some of these losses, these lenders charge higher APRs than if you had a higher score. This means the lower your score, the more you could end up paying on loans.
Whether or not you think your credit score accurately reflects your creditworthiness, unfortunately, it is not up to you. The fact of the matter is that most lenders you encounter will look at it and use it to make their underwriting decision. Some lenders may not even look deeper and look at your credit report but instead will solely base their decision on your credit score. Because your score plays such a big role in getting loans approved and receiving more favorable terms, it’s vital you pay attention to it.
What Causes Bad Credit?
Before we dive into what you can do to increase your credit score, it’s important to understand why you might have bad credit. Doing so can help you cut bad habits in the bud and be on your way to building credit back up.
Let’s refer back to the 5 components of your credit score. The main reasons your credit is poor likely stem from these components. Primarily, your payment history accounts for more than a third of your credit score. This means that missing payments is one of the things that can hurt you the most. While having a one-day-late payment does not affect your credit score, being more than 29 days late on a payment starts to hurt your score. Depending on how late a payment is, you can lose up to 100 points on your credit score. Likewise, your credit utilization has an almost equally large impact on your credit score. Even if you always pay it off, using more than 30% of your available credit each month can start to lower your score. Since these are the two most important factors, it’s very important you are conscientious about them.
Some minor things that could be hurting your credit is your credit mix, your current accounts, and hard inquiries. As mentioned, having only a few types of credit can hurt your credit score. Having various types of loans and credit can help remedy this. Similarly, having recently opened accounts can hurt your credit. Closing unused accounts and paying off your balances can help prevent this. However, be wary that closing unused accounts that you have had for many years can lower your average age of your credit accounts. This can hurt your credit score some, so make a note of this before you start closing accounts.
Lastly, hard inquiries are when lenders look at your credit report and credit score whenever you request a loan or line of credit. This usually only takes off 5-10 points each time but they can add up. Try to space them out by not requesting multiple loans every few months.
What Can I do to Keep My Score from Dropping?
You know what are some of the worst things you can do for your credit, but let’s look at some of the things you can easily do to prevent them from happening.
First, it’s best to look at the most impactful aspect on your credit score. Figuring out how you can consistently make your payments on time is the most essential part of preventing your score from dropping. There are some ways you can do this best. Primarily, making a monthly budget is one of the best ways to keep yourself on top of your payments. One way to do this easily and effectively is by utilizing budgeting apps.
Find yourself running out of money to make your payments even though you make enough money to pay them off? This is a perfect place where budgeting apps come in handy. According to the Cambridge Dictionary, budgeting is “the process of calculating how much money you must earn or save during a particular period of time, and of planning how you will spend it.” Budgeting is literally making sure you have enough money for your payment when it comes around! Let’s face it, no one is perfect and we all make mistakes. However, if you make yourself a rigid payment plan on one of these apps and you stick to it, you are sure to have enough money at the end of the month!
What if you never seem to make enough money to make your payments in-full and on time? Well, budgeting can still help you with this. Budgeting allows you to take a good, hard look at what exactly you spend your money on. There’s a chance that you are spending too much money on some things and that you can cut down spending in these areas. Budgeting can not only help you see what areas you can cut down on spending in, but it can also help you stay within the limits of your budget with alerts and notifications.
Since missing your payments is one of the worst things you can do to your credit, it’s important to know how you can prevent this. Budgeting your monthly costs out can help you have enough money to pay those bills at the end of the month!
Some credit lenders allow you to automatically make payments to them right out of your bank account. Setting up these automatic payments can be a great way to remove the stress of deadlines to make payments. If you simply have enough money in your bank account at the end of the month, the payment will be automatic, and you do not run the risk of missing your payments! However, there is a chance that these automatic payments can overdraft your account, which can cost some money in fees. Even if payments are automatic, you should still be diligent in keeping an eye on your account balance to prevent overdrafting from happening. See if your lender offers this to you on your loan or credit card account.
How to Build Credit Score
Building a good credit score is essential for having access to loans and lines of credit. Consistently making your payments when they are due is arguably the single best way to boost your credit score. However, if your credit is seriously hurting, you should not just rely on this one method to boost your score. While just simply making payments on your loan and credit card is one of the best things you can do, it is not the only way to build your credit.
Referring back to the components of your credit score, credit utilization accounts for nearly one-third of your entire credit score! Again, your credit utilization is how much of your line a credit you are using a month. Remember that lenders want to see this figure below 30%. While credit is important for being able to spend money that you do not have, it is important that you are not spending too much of it. If you are burdening yourself with tons of credit to pay off at the end of the month, you are only setting yourself up for failure. Not only might your credit score go down but it makes it that much harder to have to pay off at the end of the month. Do your best to spend below this 30% credit utilization ratio and you will find that not only are your debts easier to pay off, but your credit score actually goes up!
As we discussed, lenders don’t like to see you taking out many loans and still having a large amount of credit card debt to pay off. They also do not want to see you recently opening or applying for personal loans and credit accounts. Work to minimize this, and your credit will improve. Focus on paying off debt instead of taking on new debt. Over time, your debt accounts should decrease and your credit score will increase as a result.
Likewise, having multiple loan and credit balances looming over you is bad for your credit and bad for you. If you are struggling to pay off these multiple loans, you could consolidate your loans. This means that you take out one large loan and pay off the rest of your smaller loans. While this just sounds like just more debt, it can actually make it easier to pay off since you only have one monthly payment to worry about and one loan account you need to pay off. Shrinking your exposure to multiple sources of debt could not only make paying easier but it could reflect positively on your credit score as well.
Likewise, credit builder loans and secured credit cards are alternatives to building your credit. These both offer opportunities to build your credit by successfully paying them back, and in general are offered to those with lower credit scores, especially secured credit cards.
Building Your Credit at Possible Finance
Here at Possible, we think we have a perfect formula to help borrowers build their credit score. Now, let’s get one thing straight: Possible is not your typical payday lender. Traditional payday lenders have a stigma of having predatory practices that can actually put you in a cycle of debt known as a “payday loan trap.” While these payday lenders do offer their loans to those with low credit, it usually comes with an extremely high APR and loan terms that do nothing to help the customer. If you miss one of these payments, your APR only gets higher and it becomes even harder to pay off your loan. Even if you do successfully pay off your loan, many payday lenders still won’t report to a credit bureau.
Possible is different. We not only want to offer beneficial financial services to our customers, but we want to build value for them as well. We offer payday loan alternatives and installment loans to customers with low credit. These loans have very competitive APRs that are much better than many other lenders. Likewise, if you are struggling to pay off one of our loans, you can extend your payment up to 29 days within our app with no fees. It’s that easy.
Because our loans end up being cheaper, longer and easier to extend than most traditional payday lenders, our customers are able to pay them off much easier. When you pay off your loans at Possible, we report directly to the credit bureaus. Successfully paying your loans with us means that your credit score may increase as a result.
If you have bad credit but still need a loan or you just want to increase your credit score, a loan from Possible could be a great option for you. Convinced? Download our app today and get started!