Imagine living without credit in contemporary society. Most people wouldn’t be able to buy a house, go to university, or even buy a car. Credit has liberated us in a way that gives everyone the opportunity to have access to goods and services once reserved for the wealthy. Since credit has become ubiquitous and almost essential to everyday life, it’s important to understand what credit scores are and why they matter.
What is a credit score?
Credit refers to the act of borrowing: a lender provides you with a good or service and you, as the borrower, agree to pay them back at a later date. As credit became increasingly utilised throughout history, lenders needed a way to determine whether loaning to a certain person would be a safe investment on which they could expect a full return. From there, credit scores were born.
Credit scores are a three-digit number that represents your trustworthiness as a borrower. In other words, it’s a score that indicates to lenders how likely you are to repay a debt based on your previous borrowing history. Almost all adults have credit scores as these are automatically assigned when you apply for a credit card, loan or even sometimes when you open a bank account.
As with any other type of score, you can have good or poor credit scores. Credit scores range from 0–1200 and are held and determined by credit agencies in your country based on your personal history with past credit. Just to give you an idea, good credit scores tend to fall between 720–1200, while average to poor scores are from 0–720.
Maintaining a good credit score is important for a few reasons, which we will outline below, however, the general rule of thumb is that more significant loans and credit limits are given to people who maintain a good credit score. For example, whenever you apply for a loan or a credit card, banks request a credit report, or credit score, so they can determine the likelihood of repayment. From there, they assess the risk of giving you a loan and the amount that would be most appropriate based on your credit score. Landlords might also ask for a credit report in order to determine whether or not you are likely to pay for your rent.
What Affects My Credit Score?
Since your credit scores are calculated based on your past actions with regard to credit, agencies use related data to evaluate your credit score.
- Taking out a loan or making payments on credit cards without repaying the debt by the due date would reduce your credit score;
- Applying for multiple credit cards or loans and being rejected for credit cards or loans would be detrimental to your credit score as well.
Essentially, anything that has to do with late or incomplete payments and living on loans and credit reduces your score.
If you’re wondering how to keep a good credit score, there are certain things that can be done to to maintain it. Notably, paying your bills and credit card on time, not maxing out your credit cards or applying for new ones constantly, and paying off loans in a timely fashion can all help you increase or maintain a good credit score.
Why Do Credit Scores Matter?
Credit scores matter because they are used to assess both your financial and behavioral levels of responsibility. Though they were originally just used for lending decisions, credit scores have been adopted by insurance companies, employers, landlords and utility companies to evaluate your fiscal responsibility and more.
While good credit can be helpful to consumers, bad credit can be pretty harmful. Think back to our definition of credit: the ability to borrow. If lenders are making decisions about whether or not to give you a loan based on this one number, a bad score can prevent your from being able to access necessities such as buying a house or a car, or from getting student loans. Though poor credit does not mean that lenders won’t let you borrow money, it does mean that interest rates will be higher because they might consider you to be a riskier investment. This is also true for insurance companies, which often charge a premium for riskier clients.
Employers are also increasingly asking for credit reports before offering someone a job or a promotion. Today, approximately 25% of employers request credit reports before hiring a candidate because it gives them an idea of your level of responsibility. For example, evidence of mishandling personal finances might be representative of what would happen if they were in charge of a budget in the company. In addition, rather than using your credit report to evaluate your financial situation, employers might use it as a proxy to evaluate your level of responsibility and restraint.
A good credit rating can make it less expensive to borrow money, can automate lending decisions, render lending more fair because it curtails discrimination. Of course, the opposite is true for poor credit. However, the good news is that it is possible to rebuild and improve your credit score within a few years.
Learn more about how DCC empowers credit at www.dcc.finance
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