The basics of your credit score

DNL is all about smart budgeting, and smart budgeting starts with an understanding of how credit works.  Since we're not all economics majors, we wanted to provide you a break-down of some of the basics. 

In order to assume a given level of debt, a lender determines the likelihood that you are going to repay the loan in the agreed upon time.  In order to make this determination, lenders take heavy stock in your credit. 

Since credit determines the likelihood that you will repay a loan, good credit is required to get any type of consideration on borrowing money.  Each type of loan will have different requirements to get the money you need, but just about all loans will look at your credit score.  Because the rate of interest that is charged is determined on your creditworthiness, it is a good thing to maintain the highest credit score possible.

Your credit, as it is rated by a “Beacon Score,” or “FICO score,” is really a computer’s best guess on how likely you are to repay a loan.   The higher your credit score on the report, the more likely the computer thinks (and so will the lender) you will repay a loan.  Any late payments, collections, liens, judgments, bankruptcies, foreclosures or repossessions will reduce your credit score.

There are three companies that report credit scores to lenders: Equifax, Experian and Transunion.  They all provide relatively the same information but sometimes one will have information that others do not.  This is why it is important to pull all three credit reports.  You can get these reports for free once a year at: https://www.AnnualCreditReport.com.

A major factor in determining your credit score with these agencies is your debt-to-limit ratio.  That is because your debt-to limit ratio or “debt utilization,” is a key component of your credit score.  Your debt-to-limit ratio is calculated by dividing what you’ve spent by your total credit limit.  If you have a $5,000 limit and you’ve charged $4,000 this month, your debt-to-limit ratio is 80%.  Experts recommend keeping your debt-to-limit ratio under 30%.

With this information in hand, you can better understand what credit is, how to find your credit score and how to begin improving your credit.  Over the next couple of weeks we’ll go into how you can repair any possible bad credit, how to get and stay out of debt and how to finance major purchases.