A 5 Minute Guide To Credit Scoring

Introduction:

Credit scores continue to become an extremely popular tool used by banks and loaning institutions. However, as the economy countinues to reach new inflation highs of 4.70%, credit scores continue to symbolize the struggle of millions of Americans across the U.S. As millions of Americans obtain their first credit card and purchasing power, Gen Z currently ranks with the lowest credit score, averaging at 679. To date, approximately 33% of Americans have poor to fair scores, adding to the struggle to obtain loans despite the increasing cost of living and inflation.

What is a Credit Score?

A credit score is an algorithm used by large-scale institutions such as banks and loaning institutions to determine how likely one is to pay back their loan. Famous algorithms such as FICO and VantageScore use payment history and the length it took to pay previous loans to determine their level of risk in providing you with a loan. For example, take into account an individual obtaining a $5,000 loan, expected to be paid back within 4 months. The institution providing the loan will utilize one’s credit score by seeing their previous purchase history, the types of credit one has at their disposal(credit cards/mortgages), and how long credit history has been maintained. If the bank observes a loanee spends their credit mindfully, has a substantial credit history(10+ years), and has financial stability in their career, the loanee will have a good to excellent credit score and will obtain the loan. However, take into account an individual 18 years of age, having just opened their bank account with no credit history and poor personal financial stability due having no job or form of income. You can quickly see how the bank may think twice and potentially reject this individual from obtaining a loan due to a poor credit score.

Improve your Credit Score!

Statistics show that a credit score is at its make-or-break point during one’s college experience. In fact, the most common credit score mistakes such as a 30-day missing payment occurred during the 1st to 4th year of college, resulting in a drop of 17–37 points. Credit scores may be one of our most feared numbers but it doesn’t need to be! There are many steps one can take to ensure that their credit score remains healthy.

• Know what you can afford: Upon obtaining credit, many make the mistake of quickly purchasing expensive items that cost substantial amounts of money and can take longer to pay than expected. Ensure that you are able to cover all of the payments made on your credit cards once the bill reaches the end of the month. Making monthly budgeting graphs and spreadsheets is one of the best ways to track your income and monthly purchasing power. Additionally, ensure that monthly electrical, water, and gas bills can be paid in a timely manner to avoid a credit score drop. Keep your credit card spending low to show banks that your spent credit is low in comparison to the maximum credit limit.
• Limit the amount of new credit cards: Every month we hear of new reward cards, aimed at providing reusable points at selected institutions. These cards continue to become popularized but can easily lead to budgeting confusion and make credit scoring matters worse. These institutional credit cards similarly have monthly dues that can limit one’s ability to pay their bills and lead to consistent tracking of your credit. These institutions make matters worse by sometimes requiring that the cards be paid off in person, potentially requiring travel and limiting the ability to pay bills in time. Choosing to obtain institutional credit cards to locations you know you’ll normally use on a monthly basis is the best way to ensure that you can pay the monthly dues and avoid dropping your credit score. Unfortunately, it is small mistakes like these that result in years of a poor credit scores.
• Poor Credit Score Targeting: Many designated institutions solely provide loans to individuals with poor credit scores. Why? These institutions are well aware that these individuals are unlikely to pay off their loans in time so provide large-scale loans to make additional money from accumulating interest. These businesses normally pay close attention to one’s most valuable items such as a home and car to have readily liability in case one is unable to afford the loan. Be cautious of these loans, which can especially take place with loanees between the ages of 18–22.

What is the future of credit scoring?

Due to the worldwide popularity of credit scoring, new strategies and data are being implemented to measure risk tolerance. For example, recently the use of rental history is likely to become used in order to determine whether or not individuals are equipped to pay off loans in a reasonable and timely manner. Additionally, machine learning and AI are becoming popular tools for determining one’s credit history and creating new algorithms to improve the level of accuracy of one’s credit history. The future for credit scores is exciting, but the level of financial education and knowledge needed to protect one’s credit score will only increase and require closer attention to one’s finances.