The Complete Guide To Understand Credit Score

This weekend I was doing some de-cluttering exercise at home. Many unwanted papers I got rid off. While doing so, I came across a handwritten note at the back of my old bank statement, probably it was the first bank statement I received after opening an account with Bank Of America. The title said “A Complete Guide to credit score”.

I came to America in August 2005, I belonged to a country where there is no system for maintaining credit scores. There, Lenders, and probably government too, believe in the fact that money can be reclaimed by force.

Anyways, that’s another story, which I will touch upon a bit in various upcoming blog posts. Today’s topic is about that handwritten note.

I don’t exactly remember which online sources I used to put the notes together, it had three headings, what is a credit score, why it is important to have a good credit score and how to improve credit scores. I wrote these on the back of my three-page bank statement, which showed a bank balance (and my net worth at that time) of $2600 (August 2011).

So many things have changed since then, 6 years have passed by, my net worth is now much fold from that initial amount. My salary also got almost tripled. But the very basic things about credit score, that didn’t change.

Now my credit score is 813, I wrote a post detailing how was I able to get 813 credit score. Don’t miss reading it. It can certainly help you. I discovered a few aspects of improving the score, which was never mentioned by anyone.

This is a reproduction of the contents of the note I had written in 2005.

What is Credit Score

A credit score is a number which reflects your creditworthiness. The more the number, more your lenders feel secure that you can pay off the loan extended to you.

Three agencies maintain credit scores, Trans Union, Experian, and Equifax. They have different algorithm to calculate credit score which is closely kept secret, hence the scores vary between the three sources.

These companies make money by selling your credit score and credit report to lenders. Lenders use any of these three sources to check your score when you apply for loan or credit card.

There are two types of credit score inquiry, soft and hard. A soft query is made when the intention is just to seek information about you. A hard inquiry is made when the intention is to lend you money or credit.

Excellent credit = 720 and above
Good credit = 660 to 719
Fair credit = 620 to 659+
Poor/bad credit = 619 and below

Credit score ranges from 300 to 850. You can check credit score once a year for free ( I later developed a system of checking it for free 4 times a year, now CreditSesame and CreditKarma give real-time credit score for free at any time, though not your actual score).

A credit score is based on a credit report, which is error-prone and prone to human clerical mistakes, you should check your report for irregularity.

As a borrower, it’s your responsibility to get a good credit score whether the financial institution requires a higher or lower credit score. But remember that the better your credit score, the better the chances of getting approved for a bank statement mortgage loan program.

Why high credit score is better

You get better APR on credit cards, loans, and mortgages if your credit score is excellent. Simply more offers come your way when you have an excellent credit score (minimum 740)

Your insurance premium gets reduced when you have an excellent credit score

Many employers check employee credit score before offering a job, to judge their sense of responsibility towards duty.

Housing societies and land lords inquire credit score check your financial health and to determine if you can pay the rent every month.

When there is a need for money, you are unlikely to be rejected when you have a good credit score

How to improve credit score

Borrow money and pay on time, if you don’t borrow score won’t increase

More credit you have more will be the improvement in credit score

Don’t delay any monthly payment, always pay on time, be it utility bill, cell phone bill, rent or credit card bill.

Take most advantage of 0% interest rate on loan (car companies offer this), even if you have money for a down payment, don’t.

Keep your credit options diversified. For example, you could opt for income based loans and make sure to always keep paying your dues on time. A mix of loans that get paid back on time will surely do wonders for your credit score.

Credit card interest rates are not 0%, pay the full amount due every month to improve credit score.

Keeping monthly spending intact, if you raise the credit limit on cards, score improves

Remove irregularity in a credit report to make it cleaner, not accurate adverse reports bring down a credit score.

Last, but not least. Do not take too many loans and credit cards, even if you always pay on time, too much loan is bad for your ability to pay in future.

How score fluctuate

Credit score changes whenever your creditors report your activities to the scoring agencies, sources who maintain the scores.

These agencies are contracted by most of the banks, credit card issuing companies and various other financial institutions. They report your financial activities as soon as possible to these scoring agencies. Financial activities include applying for a credit card, paying the bill on credit card, closing a credit card, not paying a credit card etc (similarly for any other form of a loan).

If you don’t take credit, your score doesn’t change, score rarely change within a month unless you take more loan within that month.

It takes years to build a good credit score. 5 years of on-time payment record can be erased by just one month of failed payment on your loan.

Though no one knows the exact formula behind score calculation but paying minimum due on a credit card raises the score by 1, whereas, paying the full amount on credit card raises the score by 2, though this is not verified and not official.

Now when I look back to these old notes, I don’t find anything that has changed, do you? 

When I started my journey in the US, I had no score, six years down the line today I have a score of 790, I followed all the things I had written on my notes. But I wonder if I haven’t had a lovely job which I have now, what impact it would have on my credit score?