Understanding the Importance of Personal Credit Scores

Good credit scores: you’ve probably heard this term more times than you can count, and for good reason. Personal credit scores are a key indicator of overall financial health and directly impact many areas of a person’s life.

Having an excellent credit score can open many doors, whereas having poor credit can negatively impact many areas of your life from your ability to borrow money to how landlords or potential employers view you as a candidate. In short, your credit score tells a story, and it’s in your best interest to make sure it tells a good one.

At Origin Bank, our Trusted Advisors are here to help you understand the importance of good personal credit scores and offer suggestions to help you improve your overall credit rating.

Why is having good personal credit important?

A good credit score helps you reap more benefits and can impact your bottom line in significant ways.

For example, say you want to apply for a $200,000 mortgage loan. Hypothetically, if your credit score is between 620 and 639, you may qualify for a 6.788% interest rate on a 30-year mortgage. But if you had a credit score between 680 and 699, you might qualify for a 5.598% interest rate. In this example, you could potentially save $55,565.00 in total interest paid over the 30-year term of the mortgage by having a higher credit score and qualifying for a better interest rate.

Other benefits of having good personal credit scores include:

● Get better rates on insurance. Insurance carriers can use your credit score to determine whether to approve your application for coverage as well as how much to charge you. For existing customers, insurers may check your credit to decide whether to raise your premiums or even deny you the chance to renew your policies. Having a good personal credit score ensures you’ll get the best rates, and you’ll never have to worry about your coverage being dropped.

● Qualify for lower interest rates. When you apply for credit cards, auto loans, mortgages or personal lines of credit, your credit rating determines whether you’ll be approved and what your annual percentage rate, or APR, will be. Your APR is defined as the price you pay for borrowing money, so qualifying for the lowest possible rate means you pay less when repaying loans or paying off credit cards.

● Get approved for higher credit limits. A good credit rating signals to lenders that you’re a low credit risk, so they may be willing to lend you more money when you apply for loans.

● Access more housing options. Where you live can have a big impact on your quality of life and having good credit can help you land the home of your dreams. When looking to purchase a home, the better your credit, the better your chance of qualifying for a low-interest mortgage loan. And if you’re applying for an apartment or home to lease, landlords may use your credit score to determine if they will approve you as a tenant.

● Get services more efficiently and waive deposits. If you have poor credit, utility or cell phone companies will likely require you to pay a deposit before you can set up service. They may even require you to pre-pay when opening your account, so avoid these costly steps with good credit history.

● Look good to potential employers. When you apply for a job, companies may look at your credit as part of a background check. While having poor credit may not be a deal breaker, having things like low personal credit scores or bankruptcies on your history may raise red flags and cause you to miss out on job opportunities.

What is a good personal credit score?

There are two main data analytics firms, FICO (originally Fair, Isaac and Company) and VantageScore, that are responsible for compiling credit scores. FICO is used by 90% of lenders while VantageScore is primarily used by sites that offer free credit scoring. Both use a similar scoring algorithm, so the two credit scores should be similar.

Both companies offer credit scores ranging from 300 as the lowest, to 850 as the highest. Here is how each company defines its credit scoring models:

FICO Credit Scores

● Exceptional: 800+

● Very Good: 740-799

● Good: 670 – 739

● Fair: 580 – 669

● Poor – less than 580

VantageScore Credit Scores

● Excellent: 781 – 850

● Good: 661 – 780

● Fair: 601-660

● Poor: 500-600

● Very Poor: 300 – 499

How are credit scores calculated?

Your credit score is calculated using information listed on your credit report. A credit report is a statement that includes a detailed history of your financial habits such as active and closed credit accounts, open dates, type of credit and payment history for each account.

The three major credit bureaus that produce credit reports are Equifax, Experian and TransUnion. Sometimes referred to as credit reporting agencies, these companies operate independently from one another, and each has its own version of a credit report.

FICO and VantageScore take the information reported by these three bureaus to calculate your credit score, prioritizing the information by:

1. Payment History. Your payment history makes up 35% of your total credit score, making it the most important factor. If you consistently make your bill and loan payments on time, then you will generally have a good credit score. If you pay early and make above the minimum amount due, your score will often improve. If you make late payments past 30 days or pay less than the minimum amount due, this will be reported, and your score will drop. The later the payment, the worse impact it will have on your credit score.

2. Credit Utilization Percentage. The percent of credit you’re utilizing, or how much credit you currently use compared to how much total credit you have, makes up 30% of your credit score. To calculate your credit utilization percentage on a credit card, add the current balance and divide it by the total credit limit on your card. If you have more than 10% utilized, this will negatively impact your score. You can improve this percentage by paying down your credit card balances as quickly as possible.

3. Other Factors. Several additional factors make up the remaining 35% of how your credit score is determined. Things like your annual income, number of years employed, property owned, age of your credit accounts, number of credit inquiries and bankruptcies are all considerations that go into your final credit score.

Because the information on your credit reports determines your credit score and therefore your creditworthiness, it’s critical that you verify the accuracy of the reports. You can obtain one free credit report every year from each of the three major credit bureaus by visiting AnnualCreditReport.com.

When you receive your copies, check all three reports for all personal, financial or other credit information errors, as any potential errors could have a negative impact on your credit scores. Be sure to verify account numbers, addresses, credit limits and account status.

If you find any errors on your credit report, you can dispute them directly with the respective credit reporting bureau. To safeguard against errors or identity theft, experts recommend monitoring your credit using fraud alerts and other tools offered through monitoring agencies. For a list of the top monitoring services, check out this article by Forbes.com.

What’s the difference between FICO and VantageScore?

Both FICO and VantageScore are designed to predict your ability to repay a debt. So why do we need two different scores?

In a nutshell, FICO offers industry-specific scores that predict your ability to repay a certain kind of debt, such as a mortgage or auto loan. VantageScore, on the other hand, was created by the three major credit bureaus to provide consistency among credit reporting and is utilized by many free credit reporting sites.

These two models have a few other key differences to be aware of. Here’s what sets them apart:

1. Length of credit history. To generate a FICO score, your account needs to be at least six months old and actively reporting to the credit bureaus. If you use credit infrequently or are new to credit, FICO may not be able to generate your scores. VantageScore, on the other hand, can score new consumers with just one month of credit history. So, while you may not have a FICO score if you’re a new or inactive credit user, you may still have a VantageScore credit score.

2. Credit inquiries. A credit inquiry is a request for your credit file. Hard inquiries, which happen when lenders view your file when you apply for credit, impact your credit score. So, when you shop around for the best rate by applying for multiple lines of credit, this can negatively impact your credit score. To minimize the negative impact, FICO counts multiple credit inquiries within 45 days as one single inquiry rather than multiple single inquiries. This metric is beneficial when you’re looking to take out a major loan, like a home loan. By counting multiple home loan inquiries within that window as one hard inquiry, you are not punished for shopping around. VantageScore does something similar but within a 14-day window. This means that multiple inquiries, even for a variety of different loan types, count as one inquiry within those 2 weeks. However, that does mean that your VantageScore credit score may be more negatively impacted by longer loan shopping periods. But because the Consumer Financial Protection Bureau records mortgage loan inquiries within 45-days as a single hard inquiry, you don’t need to fret too much about how one score is impacted over another.

3. Data trends. On the whole, credit scores function as a snapshot of your credit profile at that certain point in time. FICO scores use borrowing and credit utilization data from the time of reporting to generate their score. VantageScore, on the other hand, utilizes data with an emphasis on patterns of behavior over time, meaning that their formula includes spending and utilization data from up to two years prior.

How can I improve my credit score?

Building a good credit score is not complicated, but it does take time. Here are some suggestions to help you raise your credit score:

● Know your credit score and check it regularly

● Check your credit reports for accuracy

● Establish monitoring to safeguard your credit from fraud and identity theft

● Make payments on time

● Keep credit card balances low

Origin Bank makes it easy with resources like our Personal Financial Management tool that helps you set up a budget and automated payments so you're never late on a bill. Visit our Trusted Advisors to learn more about how Origin can help you achieve good credit and maintain positive financial health