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Good credit earns the trust of banks- but why is that important? Have you ever had a life-changing situation that takes you from “doing just fine” to being instant need of money? Most of us have. People with bad credit get no help from banks regardless of how desperate their situation becomes.
Unfortunately, the only option for people with bad credit is to borrow from friends and family, or rely on predatory lending options- like payday loans. The more desperate you become, the more likely you’ll take any help you can get- and predatory lenders are fully aware. With bad credit, if you qualify for any loan at all, you’ll end up with sky-high interest rates and pay double, or triple, what you originally borrowed. As a result, many people spend the majority of their life in debt. Don’t let this happen to you!
If you have a good amount of money in savings and have bad credit, you are still missing out. The wealthy understand how to use other people’s money (OPM) to make more money. Earning the trust of banks with a great credit score will have banks chasing you with money to lend! Don’t believe me? Let us help you fix your credit score and watch the credit card and personal loan offers start rolling in.
However, improving your credit score is only a temporary fix if you don’t understand how credit works. Financial institutions use complicated algorithms to determine your credit scores. Also, did you know there are over 50 different types of credit scores? Let’s cover some basic credit education then take action. Or, click here to jump straight to your free credit repair consultation!
What is Credit?
You’ve heard of credit — and you know that if yours is good it can benefit you financially. But what is it, actually? It’s simple — credit measures your ability to obtain goods or services based on the trust that you will pay for them in the future.
When you apply for a loan, a lender uses your credit score to get a snapshot of how reliable a borrower you are, which indicates the level of risk involved with lending you money. The higher your score, the better a borrower you are, which means that lenders take fewer risks on you.
If you’ve been diligent about building and maintaining your credit you’ll hit payday when you apply for loans. Because you’re a good risk, you’ll find access to the best loan products — at the best, or lowest, interest rates. Conversely, your score can hurt you if it’s low — you’ll likely end up paying higher rates and getting less-than-stellar loan terms.
You’ve come to the right place for your credit education. Keep reading to learn the answer to “Why is credit important?” and find out why it’s an indicator of your overall financial health.
There are many types of credit available to borrowers, from credit cards to personal loans to mortgage loans to lines of credit — and you’ll likely end up using some, if not all, of them during your lifetime.
Why is Credit Important?
If you’ve ever asked, “Why is credit important?”, keep reading. It’s crucial to maintain a good credit score because loans are a part of life for most people. You can impact your financial life positively when you apply for a loan by having a solid history and high score. A good report can go a long way in helping you buy necessities, such as a house and a car. And it can also enable you to afford things you ordinarily wouldn’t buy, like big-ticket items.
Having good credit can affect areas of your life outside of the loan arena, too. For instance, you’ll qualify for better insurance rates — and it might even tip a potential employer’s decision because it indicates that you’re trustworthy and responsible with money. And, as you already know, it will give you access to top lenders with the best rates and terms on loans.
Different Types of Credit Scores
Just like there are many different types of credit, there are different types of scores. There are three main credit reporting bureaus that lenders report borrower activity to — Experian, TransUnion and Equifax. Each time you go to borrow money, a lender will order your report from one of the agencies and use the information on it to decide how reliable a borrower you are.
Each agency’s score can look a bit different — although all of the agencies use the information from your report to calculate your score, they treat the information slightly differently to meet the needs of each lender. In addition, one bureau might have unique information the other two do not (your information might not be reported to all three bureaus).
There are multiple FICO Score versions available, but the most widely used version is FICO Score 8. FICO scores take into account a number of pieces of your credit — and groups them into five categories, which each carry a different weight. Here’s how the FICO score categories break down:
- Payment history — 35%: This factor shows a lender if you’ve paid your bills on time.
- Amounts owed—30%: If you’re using a lot of your available credit, a lender might interpret that as you’re overextending yourself, which might indicate that you’re a higher risk.
- Length of credit history — 15%: Longer histories increase your score.
- New credit — 10%: If you’ve opened several accounts in a short period of time. Lenders might view you as a higher risk.
- Credit mix — 10%: Your score takes into account the different types of credit you have, such as credit cards, installment loans, retail accounts and mortgage loans.
FICO scores range from 579 and lower to 800+. This is what the scores indicate about you as a borrower
- 800+: Exceptional
- 740 to 799: Very good
- 670 to 739: Good
- 580 to 668: Fair
- 579 and lower: Poor
It’s important to understand that your score changes frequently. That’s why lenders typically look not just at your score, but at your entire report.
Another consumer scoring model the three bureaus use is called VantageScore. The bureaus developed this model in 2006 to compete against FICO scores and it has been steadily gaining popularity. This is how the VantageScore system weighs its categories:
- Payment history — 40%: Lenders use this to see if you’ve made on-time bill payments.
- Credit age and mix — 21%: The better your mix of account (think auto loan, mortgage, credit cards), the better your score.
- Credit utilization — 20%: This is how much revolving credit you’re using; a good rule of thumb is to use less than 30% of your limits.
- Balances — 11%: This shows lenders how much debt you currently have.
- Recent applications — 5%: Don’t open too many accounts in a short period of time because it’s a red flag for lenders.
- Available credit — 3%: Open only the amount of credit you need.
The Bottom Line
So again, why is credit important? It can make or break you when you need a loan, and affect other aspects of your financial well-being. Because it’s so important, it’s essential that you try to improve and maintain your different types of credit on a regular basis.
A good place to start is by ordering your report from the three major agencies. By law, you’re entitled to one free report per year from each bureau, which you can get through AnnualCreditReport.com. When you get your reports, examine them for any inaccuracies — if you find any, report them immediately. Never wonder “Why is credit important?” again. Cultivating and retaining your good credit is the first step toward financial security.