Managing personal finances is easier if you understand how credit score works. While spending money you already earned is ideal, some unavoidable situations might force you into taking up debt.
Of course, debt is not necessarily a bad thing. More often than not, it is the surrounding circumstances that lead to stress.
The truth is, debt can work to your advantage when it is carefully planned. If you want to avoid falling into a debt trap, you need to learn all about what a credit score is and how you can manage it better.
This article tackles the most pressing questions about credit score to help you make smart financial choices.
What Is a Credit Score?
A credit score reflects a person’s creditworthiness. It is a score that lenders use to assess the probability of timely repayment of the debt to decide whether to approve or deny a loan or card application.
The higher your credit score, the bigger the chance of your loans getting approved.
Credit scores are based on credit history, which covers a person’s total debt, repayment history, open accounts, and several other factors. A credit authority gathers all this information and keeps records for credit scoring.
Take note that the credit authority may differ from one territory to another. In Saudi Arabia, for example, the Saudi Credit Bureau or SIMAH is the only authorized national credit bureau that offers commercial and consumer credit information.
Why Is Your Credit Score Important?
As mentioned earlier, your credit score determines how you will fare in a loan or card application. But whether your application gets approved is not the only reason you need to care about your credit score.
According to SIMAH, credit scoring assesses the risk of lending to a particular consumer. As such, lenders also use it not only to decide who gets a loan but also how much they should get and how to enhance the profitability of the transaction.
Plus, a good credit score offers the following extra perks:
- Better mortgage options
- Faster business loan approval
- Better car loan deals
What Affects Your Credit Score: 3 Factors
Credit authorities come up with consumers’ credit scores based on their individual credit histories, which covers the following factors:
1. Repayment history
Even just a single late or missed payment can affect your credit score negatively. Based on the FICO scoring system (which is the basis of SIMAH’s scoring model), repayment accounts for 35 percent of a person’s score.
2. Credit utilization
How you use your credit is also a factor in your credit score. To calculate your credit utilization, the total active revolving credit is divided by your total revolving credit limit.
If you use over 30 percent of your available credit, you may be at risk of a lower credit score.
3. Credit history length
A longer credit history comes with a higher credit score. This covers:
- the period you’ve held your oldest credit account
- the age of your newest credit account
- the average age of all your credit accounts
How Can You Raise Your Credit Score?
Whether you’re planning to take up any type of loan or simply want to improve the state of your finances, you can boost your credit score by:
Reviewing your credit reports
One thing you can do to improve your credit score is to review your credit history reports. This will let you know if certain factors are working against you. You can also check what could be helping you with this particular goal.
Cultivating the following factors can contribute to a higher credit score:
- timely repayments
- low credit card balances
- diverse loan and credit card accounts
- older credit accounts
- few inquiries for new accounts or credit applications
In contrast, there may also be some things that serve as huge credit score detractors, such as:
- late or missed credit payments
- high credit card balances
- transfers to collection agencies
- judgments
If you live in Saudi Arabia, you can get all this information from SIMAH.
Using personal loans wisely
If you want to boost your credit rating fast, there are a couple of ways to do so. One of them is to get a personal loan.
Debt consolidation is one of the most strategic uses of personal loans.
Think about it like this:
With multiple credit cards, you pay every month, you’re paying for several different interest rates that could be eating up your budget.
With a personal loan, you can pay off all your credit card balances and pay back the loan on an installment basis. While you will still be paying something monthly, you’ll be cutting back on interest rates with only one loan.
When it comes to your credit score, consolidating your credit card debt will help you:
- reduce your credit utilization ratio since you already paid off your credit card balances, and
- improve your credit diversity, which most credit-scoring models consider a plus factor.
Aside from these, loans can also be used to build a better credit reputation.
One particular type of loan created precisely for this purpose is the credit-builder loan, which entails making fixed monthly payments toward a loan amount. What makes this unique is that you won’t be receiving the money until you’ve already paid everything, plus interests.
Getting a better grip on your repayments
Another simple way to enhance your credit rating is to avoid late payments, though this could be easier said than done in most cases.
Still, there are certain things you can do to go through it better.
Start by automating bill payments using features in your bank account. You can also set due-date alerts ahead of time and come up with a bill tracking system (manual or digital).
You can also change your repayment strategy for your credit card and loans. If you’re using your cards for your bills, be sure to pay the amount in full every month to avoid interest and late payment fees.
Not opening too many accounts at once
Credit authorities also look at consumers’ credit inquiries from time to time. This can range from credit limit increase requests to new financial product applications and account openings.
Too many of these done within a short period dings your credit and may damage your credit score.
Instead, apply only for what you need. You can also use a pre-qualification form online to determine whether you qualify for a new credit card if your goal is just to see whether you can make the cut or not.
Score Financial Freedom
If financial freedom is your ultimate goal, you should aim to have a better credit score. Use this article as a guide to make better financial decisions, and watch your finances fall into place.
