Many people don’t realize the importance of their credit score until they try to rent an apartment or get a loan for a home, business, car, or other major purchase. Your credit score – a snapshot of your creditworthiness at a given point in time – is a key factor that lending institutions use to determine what interest rates and other terms you will be offered, or even if you will be offered any credit at all. But most people don’t know how long it takes to start building credit for the first time or how long it will take you to build credit over time. It’s important to start early and be diligent with your credit-building efforts.
Why Do I Need a Credit Score?
Everybody – yes, all of us – needs a credit score, which fluctuates constantly, depending on how well you are managing your credit. In fact, you have multiple scores, so it’s important to know where you stand. Credit scores typically range from 300 to 850, but you’ll want to be closer to the top of that range. Lenders base their loan terms almost exclusively on your credit scores. There are various ways you can access your most important scores and reports, through various channels, including www.annualcreditreport.com, which is free to you. Click on the link to see how easy it is to get regular updates on your credit score.
How Can I Check and Keep Track of My Credit Score?
The most widely used credit scoring model is the FICO® score, developed by Fair Isaac Corporation. The three major credit bureaus — Equifax®, TransUnion®, and Experian® — use the FICO scoring model for their systems. Because each scoring system has slight variations, your score from each bureau may differ. Lenders may turn to different bureaus for credit scores based on their criteria, so it’s important to know your score with each of the three major credit bureaus. Under federal law, each three bureaus are required to give you a free credit report every 12 months if you ask for it. This allows you to understand what is in your report and identify any inaccuracies that you want to correct.
How are Credit Scores Calculated?
There are several factors that go into calculating credit scores. Here are the key factors1:
1. Payment History (35%):
Payment history refers to your track record of making timely payments on your credit accounts, including credit cards, loans, and other debts. Payment history is the most significant factor when it comes to determining your credit score. Paying your bills and loans on time demonstrates your ability to manage your debts responsibly. Consistent on-time payments positively impact your credit score, while late or missed payments can severely harm it.
2. Credit Utilization Ratio or Amounts Owed (30%):
Credit utilization ratio measures the amount of credit you’re currently using compared to your total available credit limit and is typically expressed as a percentage. Maintaining a low credit utilization ratio is helpful for a good credit score. Using a large percentage of your available credit suggests financial stretch and can even indicate a higher risk of default to your credit providers. Keeping your credit card balances low relative to your credit limit (ideally below 20-30%) demonstrates responsible credit management and can positively impact your score.
3. Length of Credit History (15%):
Length of credit history is the length of time your credit accounts have been open and active. A longer credit history generally results in a higher credit score. Lenders like to see a track record of responsible credit use over time. It helps them quantify your stability and reliability as a borrower. Opening new credit accounts may temporarily reduce your average credit age, so it’s important to keep from opening new lines of credit or credit cards to frequently.
4. Types of Open Credit (10%):
Types of open credit refer to the mix of credit accounts you have, such as credit cards, student loans, mortgages, etc. You may find it surprising that having a diverse mix of credit types can positively impact your credit score. It actually demonstrates your ability to handle various types of credit responsibly.
5. New Credit (10%):
New credit accounts for recently opened credit cards or loans and hard inquiries on your credit report. This can be from opening a new credit card, taking out a new car loan application, etc. Opening too many new credit accounts in a short period can temporarily lower your credit score. This is something you want to stay away from doing, especially when you want to keep your credit card steady, like when you’re about to get a new mortgage, refinance, or even renting a new apartment and need to show a strong credit score. Be smart about making multiple credit applications within a short timeframe to avoid negative impacts on your credit score – especially when you’re going to need to show a high credit score soon.
Getting Started: How Long Does it Take to Build Credit from Scratch? For people with no prior credit history, building credit from scratch can be a lengthy process. FICO suggests that credit scores can be calculated for those with at least six months of recorded payments, while Experian recommends 36 months of credit activity to generate a score. It’s important to understand why some people don’t have a credit score and why you should not be one of them. You can start with a small personal loan or open a credit card account. Make the loan payments on time and use the credit card lightly and pay the balance in full each month. Voila, you are building a credit history!
For college students who are working to build good credit, one option to consider is a secured credit card, like the Ambition student card from College Ave. A secured charge card marries a security deposit with a credit card. Parents or the student deposit money onto the card. The student can’t spend more than this amount, so there is no worry about going into excess debt. As the student pays off the card, the issuer reports on-time monthly payments to the credit bureaus, which can help the student establish a credit history and score.
Sign Up for the Ambition Student Card
How Long Does It Take to Increase Your Credit Score? Can You Build Your Credit Score Faster?
How quickly you can improve your credit score depends on your starting point. If you already have good credit, it may not take long. But going from no score (which is common for many high school and college students), or a poor score to an excellent one takes time and effort. There are, however, ways to do it and do it faster. They include tracking your spending and setting up all your debt payments to be made automatically, which avoids score-dinging incidents of missed or late payments. Using several types of credit, such as an auto loan and a credit card, to show potential lenders you can handle several kinds of debt. Using credit cards lightly and paying off the balance in full each month. Avoiding such credit-score-damaging behavior as missing a payment or exceeding the limit on your credit card. And, taking advantage of financing options, such as a secured charge card, that are designed to help young adults establish credit.
Why is it important to establish a good credit history?
We’ve all heard someone brag about being debt-free and not needing credit. Although that’s good for them, it’s unrealistic for most people to go through life without needing credit. Besides, your credit score influences so much! Lenders use credit scores to help them assess whether you are a good fit, and they often give the most favorable terms to the applicants they consider “good bets.”
For example, on a $200,000 thirty-year mortgage, a top-tier credit score (760-850) might secure a 3.307% interest rate, resulting in a $877 monthly payment. But a lower credit score (620-639) might lead to a 4.869% interest rate, with a monthly payment of $1,061. This difference amounts to an additional $184 per month or $66,343 over the life of the loan! And there are other benefits to a good credit history, including better access to loans, opportunities for credit card “rewards,” lower car insurance premiums, more housing options, and possible security deposit waivers on utilities.
Like a high school report card, a credit score is not just a number. It can greatly affect not only your financial life but also the choices and opportunities you will have throughout your lifetime, including where you will live, your ability to get student loans or qualify for a vehicle lease, and whether you will enjoy perks from a credit card and get the best deals. Start now to build and nurture a good credit history – it can help simplify and enrich your life for years to come.
