It's surprising to know that credit scores have 30 different levels. A lot of people are not aware of this fact and when they try to look for the best credit score, they are bombarded with various answers on search engines which often leads to confusion. Sometimes, the information they get is misleading and takes them down the wrong path. Hi, my name is Joe Mahlow. For over fifteen years, I have been working in the financial literacy and credit repair industry. As part of my goal in sharing expert advice on different financial topics, I will be discussing one of the most important topics today: credit scores. Having helped over 20,000 clients improve their credit scores over the years, I am confident that I can provide you with enough knowledge on the subject to help you do the same. Let's dive in!
Contents:
Understanding Different Types of Credit Scores
Understanding What Constitutes a Good Credit Score
Determining the Ideal Credit Score for Home Buying
Determining Your Eligibility for a Car Loan
Methods to Increase Your Credit Score
Tips from Joe for Improving Your Credit Score
Understanding Different Types of Credit Scores
Credit scores are essential in determining your creditworthiness when applying for credit. Two different credit scoring models, the FICO model and the Vantage model, are commonly used. To understand this better, here’s what you need to know:
FICO Credit Score
The FICO scoring model is the most widely used, with eight different models ranging from FICO 2 to FICO 10. Each model calculates your credit score differently based on the lender you’re applying with, resulting in the need for various models. For example, mortgage lenders use FICO 5 reports, while credit card companies use FICO 8 reports, weighing your payment history for each respective type of credit.
Vantage Credit Score
The Vantage Score was developed by three major credit reporting agencies – Equifax, Experian, and TransUnion – as a competitor to FICO. Although it’s relatively new, it’s gaining popularity in some sectors such as personal loans and auto lending. However, it’s not widely used for lending purposes, making it less accurate than FICO.
FICO vs. Vantage
While Vantage can give you a good idea of your FICO score, FICO scores are still the most recognized and used by lenders. Vantage may be useful for monitoring credit but isn’t entirely reliable for lending purposes. However, it’s worth noting that credit reporting agencies are the most extensive data collection agencies and will continue to refine their scoring models to provide the best data for consumers and lenders alike.
To see your credit scores using both models, go to www.myfico.com and sign up for an account.
Understanding What Constitutes a Good Credit Score
Both FICO and Vantage scores span from 350 to 850, with 350 being the lowest and 850 the highest possible score. It is essential to track your progress while working to achieve a good score. Here is a breakdown of crucial score thresholds:
620 or below
If you have this score or lower, it is considered a bad credit score. The situation may arise from a poor credit history, high-balance credit card accounts, or the absence of credit cards. To improve your score, ensure you have ten active revolving credit accounts and pay your bills on time. Consider secured credit cards such as the Credit Builder Card or OpenSky Credit Card. Reaching the 620 credit score range means you are eligible for an FHA home mortgage.
640-680
Scores in this range indicate fair-to-good credit. You have apparent credit history, possibly some derogatory marks or accounts on your credit, and high balances on credit cards. Hence, paying down your card balances will be critical. New accounts can also temporarily lower your score.
740+
A score above 740 is considered "super-prime" and guarantees the best possible interest rates on loans. If you belong to the 20% of Americans with this score, congratulations! Keep your credit card balances low and pay your bills promptly to maintain your score.
Determining the Ideal Credit Score for Home Buying
The answer to this question is reliant on the type of mortgage loan you plan on applying for. Mortgage loans have similar and contrasting requirements and standards due to federal rules and government support. The three most frequently used mortgage loans are FHA loans, VA loans, and conventional loans.
Conventional Loans
Conventional loans are the most favored and often the most economical choice for securing a loan, aside from VA loans. These loans do not require private mortgage insurance (PMI), which could increase monthly or down payments. PMI is an arrangement that safeguards the lender in the event of your non-payment. Conventional loans mandate a credit score of at least 640 and a debt-to-debt ratio of no higher than 43%. They also usually ask for a lower down payment and present a better interest rate.
FHA Loan
FHA mortgage loans cater to a lower credit score ranging from 580 to 619. Keep in mind that there are several different loan programs, so it's best to shop around for lenders offering the best option best suited to your financial capability. FHA loans require PMI for at least 11 years to be added to your mortgage, which again, could dent your budget. However, this loan offers a debt-to-income limit of up to 50%, allowing for a broader range of homes to be bought with a lower income. Down payment is as low as 3.5% of house purchase, which is lower than a conventional loan but could incur higher interest rates.
VA Loan
VA loans do not impose a credit score requirement, but will take a look at past default loans and any existing arrears to government entities during your pre-qualification. Eligibility criteria include serving atleast 181 days in the U.S. Military, serving 90 consecutive days during wartime, serving 6 years with the National Guard, or having a deceased military spouse during active duty. VA loans offer reasonable interest rates and usually do not require a down payment. It is a perfect way to give back to our veterans.
Determining Your Eligibility for a Car Loan
When it comes to buying a car, credit history matters more than credit score. Though having a higher credit score is indeed important, it has a lesser role in the interest rate you'll qualify for. This is because lenders assess the risk of extending credit by looking at your credit history, current and previous, when you apply for a car loan. For instance, late payments or repossession of a current or previous car loan can decrease your chance of getting approval, whereas having a clean slate works in your favor. Even with a bad credit score, some lenders will still qualify you for a car loan but will require specific criteria to be met, such as higher down payment and dealership fees, to counterbalance the risk. Dealerships pay a fee to help mitigate the risk of extending loans to high-risk borrowers, and this ultimately results in you paying more for the car and interest. Hence, it's essential to build equity or a down payment when buying a vehicle on credit.
Ideal Credit Score Range for Buying a New Vehicle
There is no credit score that guarantees approval, and eligibility depends on various factors. Having said that, an excellent credit score range is above 680, which can determine interest rates. Scores below 680 means you pose more risk to the lender, and as a result, you'll be charged higher interest on the loan. The amount of interest you pay will depend on your credit score, as indicated in this example:
Someone with a credit score of 720 or above will pay an average of $5,500 in interest on a loan.
Someone with a credit score of 680 or above will pay an average of $6,600 in interest on a loan.
Someone with a credit score of 650 or above will pay an average of $8,100 in interest on a loan.
Someone with a credit score of 615 or above will pay an average of $10,200 in interest on a loan.
Someone with a credit score of 580 or above will pay an average of $13,900 in interest on a loan.
Someone with a credit score of 579 or below will pay an average of $15,300 in interest on a loan.
Based on this data, having a higher credit score means paying less interest over time, which in turn improves your credit score.
Methods to Increase Your Credit Score
If you're wondering how to raise your credit score, there are several things you can do to improve it without a lot of effort. However, building a good credit score takes time; it's not an overnight process. Therefore, patience is essential to avoid making irrational or poor credit decisions, which only worsen the problem.
Here are some points you should focus on to improve your credit score:
1. Open 3-5 Revolving Credit Accounts (Credit cards)
Revolving credit is an excellent way to boost your credit scores with less effort. Obtaining a large loan typically takes time and effort, so this option is ideal for people with limited credit or those rebuilding credit. A secured credit card such as Open Sky or Credit Builder Card is a good option to start with as they focus more on your ability to pay on time and having no history of bankruptcy in the past two years. Revolving credit accounts make up approximately 30-35% of your total credit score, making them the best option to increase your credit score quickly. Although it may take 2-4 months to show an increase, it's essential to pay your balance on time and keep it around $5-$10.
2. Request a Credit Limit Increase
If you have active revolving credit card accounts, you can request a credit limit increase for your credit cards to increase your overall credit limits, ultimately lowering your credit utilization percentage. This is critical since high credit card balances that exceed 30% of your overall limits can hurt your credit score. Each credit card company has a different process, so it's essential to either check online or call the company and ask them how to increase your credit limit. Ensure you have an excellent payment history on your credit card for 7-15 months before requesting a credit limit increase.
3. Manage Your Balances
Keeping your balance low and close to zero is crucial to improving your credit score. You are not obligated to use your credit cards every month, so it's important to use them for small purchases. When paying your bill, leave about a $1-$5 balance on your credit cards. If your credit card balances are high, create a game plan to pay an "x" percentage of your paycheck every month to pay off your credit card and preferably stop using it. Limiting your credit card usage is vital since credit card spending habits significantly impact your overall credit score. Additionally, the rates on credit cards are high, with most payments going towards interest rather than paying down the balances.
Tips from Joe for Improving Your Credit Score
Credit problems are common and can happen to anyone. However, if you are serious about improving your current credit situation, it is important to put in the necessary efforts. You will soon realize that you can make significant changes to your credit score in a relatively short period of time. Many people with poor credit fall victim to perpetual credit issues that they believe are impossible to overcome. However, building a great credit score requires patience, perseverance, and a willingness to focus on your spending habits. The first step towards credit improvement is to create a budget that enables you to identify and fix any bad spending habits. This can have a direct impact on your credit score. Further understanding of credit is explored in this article for your benefit. If you require assistance with credit repair or are looking for guidance, feel free to connect with my office today at www.asapcreditrepairusa.com.