About Credit Ratings and Credit Scores
Your credit rating is an assessment of your credit worthiness, or your ability to pay back your debts. A credit rating is calculated by looking at your financial history and your current assests, income and liabilities. Financial history covers a multitude of things, from how well you handled past debt obligations, such sending payments on time and staying within credit limits, to whether you pay your cell phone, cable or internet bill properly, on time, and in full. A lack of credit history will lead to higher interest rates and deposits for loans, as a lender doesn't have anything to use as a basis in judging your credit worthiness, and as a result, tends to err on their safe side.
A poor credit rating indicates you have trouble handling existing debts, and also points to a high risk of default. As a result of this history, people with poor credit ratings are more likely to be denied loans and also will have higher interest rates to cover the higher risk the lender takes on.
In the U. S., a person's credit worthiness is given a number called a FICO score. The score ranges from 350 to 850, with 350 meaning extremely high credit risk, while 850 is an extremely low credit risk.
The credit score is given by your history in 5 categories, each with a different weight in the score. 35% of the score is previous credit preforance, or whether you paid your past bills on time. 30% is your current level of indebtedness. If you are deep in credit card debt with a minimum wage job, your score in this category will not be great. Also, if you have large balances on existing revolving debt (i.e. credit cards) relative to your credit limit, your score will suffer. If you have just a couple cards but you consistently have your balance near your credit limit, banks assume you are nearing your limits financially, even if you aren't. So to improve your score here, pay down your debt. 15% comes from the time your credit has been in use. The longer you have been using credit, the better your score will be. This also means that having long relationships with your creditors is a positive. Creditors don't like to see potential customers opening and closing accounts every 6 months. 15% also comes from the types of credit available. Having more variety of credit shows creditors how you are capable of handling different types of debt. Paying your credit card bill on time and paying your house payment on time have different rankings in level of importance for many people, and banks have learned this. Lastly, 5% comes from your pursuit of new credit. A person applying for a new credit card twice a month smells like financial desperation to banks, and financial desperation is something lenders tend to avoid.
As a college student, money can get tight at times, but still efforts should be made to pay all bills on time and in full, or in the case of credit card bills, at least as close to the full balance as possible. Credit ratings take a very long time to get up to a good score, but can be ruined very quickly. In this sense, banks are once bitten, twice shy. A late payment or two can put a big ding in one's credit score, and that can lead to higher costs (interest rates) for future credit cards, auto loans, and home loans.
Also, many other people you might not think of may pull up your credit score for a variety of reasons. Landlords may look at it to see if you would be a responsible tenant and pay your bill on time. Many employers look up scores on job candidates to see what sort of responsibility they show in their life. Auto insurers have also been known to look up scores for similiar reasons, and as a result, set your payment accordingly. So as you see, your credit score is being read as virtually a responsibility and risk score for other more or less unrelated areas.
Bottom line, your credit rating is a resposibility and trustworthiness rating. Do your best to make it a positive reflection of you.
Check out your credit report for free. This is the site the was made by a recent Congressional bill, and is completely free. Some other sites charge monthly fees after you sign up for the initial free trial.
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