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Money, loans, and credit aren't always comfortable or interesting topics to discuss, but understanding how credit scores and reports work can be critical to your personal financial success.
Most of our education systems don't emphasize financial literacy. We may learn the Pythagorean Theorem as teenagers, but not the basics of managing money, much less how a credit card works or what a credit score is. For many young people starting their professional life, knowing how to manage money is far more important than knowing how to determine the angle and sides of a triangle.
When it came to credit cards, what was drilled into my head was: "If you can't afford it, you don't buy it." Furthermore, as a golden rule, I was taught never to use this payment method, as credit was viewed simply as a gateway to debt.
For affordability, that's sound advice. Still, as I found to my detriment when I tried to sign up for my first mobile phone contract (and was rejected as I had no "proof" that I was "creditworthy"), it's far more beneficial to manage affordability and at the same time build a strong credit history and score.
And, the earlier you can start, the better.
A credit score is more than just a three-digit number. It has far more meaning than you may realize as life-changing events, such as buying a house or a car, are made possible (or can be denied) based on how credit agencies interpret your score and, therefore, how lenders view you as a credit risk.
Here's what you need to know about credit scores, credit files, and how to either build or repair your existing credit score.
A credit score is a three-digit number, between 300 and 850 in the US, (or between 0 and 999 in some countries), intended to represent your "creditworthiness." This term is used to describe how likely you are to stick to financial agreements.
Your credit score predicts your financial responsibility and the likelihood of you paying back a loan, and on time.
Credit scores are used to help companies decide whether to offer you mortgages, vehicle financing, credit cards, personal loans, Buy Now Pay Later (BNPL) services, and other forms of finance.
Credit bureaus and lenders may vary in how they assign credit scores and what influences are used to come up with a number. Mathematical models, from such firms as FICO or VantageScore in the United States, determine your score.
As noted by Equifax, most bureaus use models and ratings similar to these:
In the UK, there is no universal credit score, so score ranges are different between the three credit reference agencies, TransUnion, Experian and Equifax:
As a general rule, the higher your credit score, the better.
Credit scores are determined through your financial history, existing credit accounts, the number of credit lines you have open to you, and the overall amount of debt you have.
There are three main bureaus in the US and UK: TransUnion, Equifax and Experian. Not every lender, however, reports to these credit reference agencies and so you may find discrepancies between different credit report companies when you check your score.
As an example, FICO will determine your credit score based on the following factors (although other models may use different percentages):
In addition, some credit report companies may only pull data from one or two bureaus, or take a mix of all three. Therefore, looking up your credit score can only provide a rough guide to your "actual" credit score and creditworthiness, as it doesn't really exist as a single figure.
Confusing a credit report and a credit score is an easy mistake to make.
A credit score is a three-digit number representing your creditworthiness based on an evaluation of your credit report. A credit report offers a deep delve into someone's financial history.
A credit report will list personal information and "influences" that impact your credit score, both positive and negative aspects. This includes:
In the past, your credit report would be provided to you in one lengthy document, but today you can access mobile and web portals which have a more user-friendly interface and that will show you any alerts or problems with current lending arrangements.
As lenders will often update credit agencies monthly, or whenever a significant change occurs, credit report updates can take a while to appear.
Some agencies will also provide "action plans" when a user views their report which offers advice on boosting credit scores over time.
Credit reports can be a real asset for personal security today.
Unfortunately, it seems that every week we hear of a new data breach impacting an enterprise organization. When these incidents occur, consumer personally identifiable information, or PII, is often stolen, sold or leaked online.
This information may include names, physical addresses, email addresses, dates of birth, telephone numbers, Social Security or National Insurance numbers, scanned copies of ID cards, and payment card data.
These datasets can be used to perform social engineering, to potentially clone cards for making fraudulent purchases, or for ID theft, which can seriously impact your credit score.
A cybercriminal may take out loans or financing in your name that you are unaware of, for example, as long as they have the right information.
In the last few years, some credit agencies have begun linking credit reports to data leaks online and performing scans on their customer's behalf, alerting them to any detections concerning the sale or leak of PII. When you become part of a company data breach, the victim firm will also often offer free credit monitoring as a way of apology to customers.
When you apply for new credit, such as a credit card, a loan, or a BNPL service, the lender may check your credit history.
These checks are defined as soft and hard checks. Lenders, employers and other services require your permission to perform either check.
Soft pulls will be visible on your credit report, though.
Companies performing these inquiries ask for access to your credit report to determine your creditworthiness, to see if you've recently applied for other lines of credit, and whether or not you have defaulted on past loans.
Hard checks are associated with more significant forms of borrowing, where the risk to the lender may be higher if you default.
As an example, hard pulls are standard during the mortgage approval process. If lenders see a litany of missed loan payments on your credit file, for example, they may consider you too much of a financial risk to accept or impose higher interest rates.
Hard checks will typically impact your credit score and may lower it by a few points, but this is temporary and shouldn't be of enormous concern. The caveat is that if you are applying for credit numerous times in a short period, the cumulative effect of hard checks could be more obvious.
Experian reports that a single hard check may impact your credit score by five points or less.
Hard checks may stay on your report for up to two years and become part of a timeline for when you have applied for credit -- a factor that other lenders may consider when they perform their own checks in the future.
See also: The 5 best credit cards you can (and should) keep forever | How to build good credit during college
Requesting your credit score or report will not lower your score.
You shouldn't be frightened at the prospect of checking your credit file -- and by keeping a close eye on your report, you may be able to catch any signs of fraud or ID theft early, actually being of benefit to keeping your score in check.
Many credit reporting agencies offer consumers free and paid options to check their credit scores.
The average FICO score in the US is 714, according to Experian, although this varies between states. In the UK, this number is 797.
They might seem high, so if your score is on the lower end, don't worry. It takes time to build up a good credit history -- for example, you couldn't expect an 18-year-old to have the same score as someone who has been financially responsible for years and is in the 55+ age bracket.
If you have built up a reasonable credit score -- generally speaking, "good" and above -- this could mean that you are accepted for higher loan amounts and on more favorable repayment terms.
For example, two people could apply for vehicle finance. One has an "excellent" credit score, whereas the other has a "poor" rating. The candidate with an excellent score will be able to sign the deal with better credit terms, including a lower interest rate on the loan, and, therefore, will pay less throughout the agreement.
However, the candidate with a poor score may be considered more of a financial risk and so may have to agree to a higher annual percentage rate (APR) with less flexible payment terms -- likely paying more in the long run.
Some types of financing may also be out of reach for someone who doesn't have a good credit history, such as personal loans or mortgages.
In general, issues that can negatively impact your credit score are:
So-called "adverse events" can severely impact your credit score for a long time and may prevent you from being accepted for loans, new bank accounts, service contracts, and other types of financing.
"Adverse events" include financial or legal problems of note, such as county court judgments (CCJs) and/or civil case judgments, bankruptcies, individual voluntary arrangements (IVAs), serious loan defaults, foreclosures, and other problems in the public record.
Legal judgments, such as when someone sues you over an outstanding debt and wins, may stay on your report for six to seven years, depending on the country. Civil judgments now have to meet new legal criteria in some countries to be included in your report -- for example, in the United States, due to the Fair Credit Reporting Act -- and it may also be possible to appeal for civil records to be removed from your file if you believe they are wrong or unfair.
According to Lexington Law, some states require judgments to be removed from credit files once debts are paid.
Tax liens, which are legal claims on your assets, also used to be featured on credit reports. Bankruptcy filings, however, may still appear for up to a decade.
Even if you have severe marks against your credit, and will have them for a while, it doesn't mean you can't improve your credit score until they expire -- although they may undermine just how far it can be improved.
An important but sometimes overlooked area of your overall chances of obtaining credit is the linked addresses and financial ties to other people contained in your credit file.
Individuals you have financial ties with -- whether through joint bank accounts, business ventures, or legal judgments -- may be connected to your credit report.
While simple connections may not officially impact your credit score, some organizations might consider your existing and past financial associations when they are making a lending decision.
It's not that getting married, for example, means that you both now have a merged credit score. Rather, opening a bank account or jointly applying for credit means that lenders could look at both of you and your spouse and consider both of your credit histories.
You should, however, be cautious if, and when, you decide to tie yourself financially to someone. Say you have a housemate and you are both jointly responsible for paying a bill. If your housemate refuses to pay, this could appear on both of your credit files and, thereby, negatively impact your scores.
While standard loans and financial agreements often impact your credit score, BNPL is a different breed of financial product.
BNPL providers, such as Klarna or Afterpay, will often only perform a soft check -- if any at all -- and will not generally report payments to credit bureaus. The caveat, however, is that late payments may negatively impact your credit score.
See also: Buy Now, Pay Later: Flexible payments for inflationary times, or a road to debt?
Author's note: As a personal example, my credit score jumped up several hundred points overnight once my address was updated, and all it took was a five-minute online correction request.
Either method has merit, and overall, can be used as debt-reduction strategies that could eventually mean you have more disposable income and less credit utilization. It might also be worth using balance transfer cards, which often offer a zero- or low-percent APR, to help you deal with high APR debts.
Author's note: This is not financial advice, however, as an example, I used to have a credit score in the 300s as I had few financial agreements, an overdraft dispute hanging over my head, and little credit history. I applied for two high-interest credit building cards, from Luma and Barclays, and used each one, once a month, on shopping essentials. I paid each card off in full the next day without fail and repeated this process for roughly two years. They contributed to a massive improvement in my credit score.
You see the adverts online and on television, with companies promising a quick boost and fix of your credit score in return for a fee. As noted by the US Federal Trade Commission (FTC), there's no quick fix for credit score repair and many of these organizations are likely trying to scam you.
There have even been investigations launched by the FTC into the deceptive practices of credit repair companies.
However, some legitimate firms and charities out there provide credit score coaching and mentorship, such as Operation Hope and the National Foundation for Credit Counseling (NFCC), rather than promising to remove negative influences on your credit report overnight. They may also take on disputes on your behalf, such as requests to remove debts or legal judgments that don't belong to you.
"The fact is there's no quick fix for creditworthiness," the FTC says. "You can improve your credit report legitimately, but it takes time, a conscious effort, and sticking to a personal debt repayment plan."