Credit History 101
January 10, 2020 by Daniel Azzoli
Building your credit history may be challenging, but it may get easier when you understand how your everyday financial decisions impact your score.
When it comes to your finances, your credit score is an important number. Lenders may look at your score to determine the chances you’ll pay back a loan on time, and what they see may help them determine the rates and terms of the loans they grant.
Generally, the higher your score is, the easier it may be for you to qualify for loan products with low rates and favorable terms. As your score drops, your options may begin to taper off.
If you’ve started to see your borrowing options shrink due to your three-digit number and want to know more about it, you’re in the right place. Not only are online loans from MoneyKey a convenient cash-flow solution in an unexpected emergency, but we’re also a source of invaluable financial information.
Welcome to MoneyKey’s Credit History 101. Here you may find out how you may end up with the score you have so you can answer another important question: how can you start building your credit history?
What is a Credit Score?
Before you can run, you have to walk. So first, let’s start with the basics.
A credit score is a three-digit number which is impacted by a number of different factors and it is used to evaluate your performance as a borrower. If you don’t know what yours is, register with AnnualCreditReport.org to find out.
How and why are you assigned the number you have?
It depends on what’s in your credit file, which shows a broader rundown of your borrowing and repaying habits.
If your lender shares account activity to one or more of the major credit reporting agencies (CRAs), your loan account will be in your file and it may impact your score.
Some lenders may report things like your payment history, amounts owed, and the age of your accounts every time you pay (or don’t pay) your bills.
A CRA organizes this information and runs it through a credit scoring model. This is a complex algorithm that compares your past habits to statistical data.
Credit Scoring Models Explained
How many credit scores do you think you have? If you say just the one, you may be off the mark by a hundred or more!
This is because there is no singular scoring model used by every financial institution. Credit scoring models may vary by lender, reporting agency, and industry.
There is, however, a pretty good chance that your three-digit number is a FICO score. FICO, or the Fair Isaac Company, is involved in 90 percent of all lending decisions, and it’s often the first one used by financial institutions.
The FICO scoring range spans 300 to 850. Other common credit scoring models generally use the same range.
While some models operate on a range of 300 to 850, it’s important to note that some don’t — which means you may have a score higher or lower than these common benchmarks. It depends on the algorithm used to crunch your report.
How Are You Supposed to Track All of Them?
Luckily, no one expects you to memorize the hundreds of different numbers you might have at any given time.
Rather than agonizing over individual scores, a more practical approach is understanding what the different credit scoring models have in common.
While the exact math behind these credit scoring models may vary, they tend to base their algorithms around the same basic factors. Check out the table below to see the main factors some scoring models consider when calculating your score:
To see how often you pay your bills on time
To see how much overall debt you carry
To see how much of your limit you use on a regular basis
Age of Accounts
To see how long you keep accounts open
Type of Accounts
To see how many different kinds of accounts you juggle
To see how often you apply for new accounts
How big an impact each factor has on your score may vary according to the model used, as one may weigh a category more heavily than others when generating your score.
Their numerical value may be unique to each model, but the basics stay the same: what usually reflects well in one report will generally reflect well in another as well.
What is a Prime Vs Subprime Credit Score?
When it comes to categorizing your score, there is a gradient of ratings. They run the gamut of the low to the high and everything in between.
But these are just finer details to a larger division of scores. Every bad, poor, fair, good, and excellent score falls into two wider categories: prime and subprime.
Since individual credit scoring models may have unique scoring ranges — and there are a lot of models in use today — we’re going to focus on FICO as an example.
With few exceptions, a prime FICO score is generally anything from 620 and up. Excellent, good, and some fair scores fall under this umbrella term.
A subprime score is anything that’s below 620 and tends to describe bad and poor credit.
While you may get your payday loans online even with a subprime score, having a prime number generally improves your chances of qualifying for a wider variety of loans.
What is a ‘Perfect’ Credit Score?
The FICO model tops out at 850, making this the highest credit score possible. Few people have this number in their file. They make up just 1.2 percent of all FICO scores in the U.S.
Thankfully, you don’t need the highest credit score possible to borrow from lenders. According to FICO, a score above 760 will generally unlock great interest rates.
Comparatively, you may notice a difference in the loan products offered to you once you drop down to good or fair ratings.
Getting the highest credit score possible may be your ultimate goal, but it may be a good idea to first understand prime vs subprime ratings — especially when you’re starting to build your credit history.
How Do You Get into the Prime Zone?
What it boils down to is proving to lenders that you pose little to no risk should they grant you a cash advance. To do this, you may have to commit to good money management habits.
Ultimately, building your credit history hinges on your ability to perform well in the factors used by most credit scoring models.
Some of the things that may impact your file include:
Paying your bills on time
A positive payment history strongly indicates that you’ll pay back future installment loans on time.
Paying off balances
You’ll want to pay off your balances in a timely manner to avoid negative entries in your report from missed payments, and to keep a low credit utilization rate. You want to use no more than 30 percent of your limit at any given time to keep your utilization rate low. This rate is a strong indicator of your financial health.
Limiting new loan applications
Spacing out installment loan applications or other applications for new accounts will help buoy your average account age and reduce the impact an inquiry may have on your file.
Diversifying your profile
Being able to juggle a variety of different accounts well will look good only if you keep them all in good standing.
Your Score Will Change
Your score is a dynamic number that may change with each decision — good or bad. Just because you add good entries to your file one month, doesn’t mean your score will be increased the next.
The road to life can be paved with the best intentions, but sometimes, you may hit speed bumps along the way. A family emergency or health scare can make it difficult to juggle everything at once, and your finances may suffer as a consequence.
The good news is, every entry in your report has an expiry date — even the bad ones. Derogatory marks generally slide off your report after seven to ten years, after which they won’t impact your score.
Depending on your starting point, your journey to improving your credit may be impacted by many factors.
How to Start Building Credit History
Building your credit history is no picnic when you may not have traditional accounts that report activity to a CRA.
As a side note, sometimes even those bills that don’t ordinarily get reported may impact your score. While utility bills and even some cash loans may not establish a positive payment history, these providers may involve a CRA if your accounts become delinquent.
It’s important to live within your means, so it’s easier to keep on top of these bills. Paying these bills on time and maintaining a low utilization rate will keep these lenders from sharing bad entries on your file.
That being said, you can’t build history through an absence of bad credit alone. You have to have ‘good’ examples in your file.
Here is a tip that may pack on an example of ‘good’ credit.
Leverage Your Bills
In many cases, things like rent, utilities, and your phone bill stay off your file when they’re in good standing. It’s only when you start to fall behind on these bills that your creditors get the major CRAs involved.
If they do, they may share late payments or delinquent accounts, and this info may impact your score. But what about all those months when you pay on time or even a little early?
You might be able to get your positive payment history to count by leveraging these bills in your favor.
Did you know housing costs take up 37 percent of the average American’s budget? Since rent is likely the biggest, most regular bill you pay every month, this is a great place to start.
You may be able to get your payments added to your file by using a rent-reporting service.
Some of the biggest rent-reporting services are:
Remember, any rent payment will be shared once you start using these services — and that includes late ones. Make sure you can pay these bills on time to see the best impact on your report.
Budgeting for this expense may be new to you if you’re just starting your freshman year. Check out these budgeting tips for college students to make sure you always set aside enough cash for rent!
How Long Does it Take to Build Credit History?
As we draw a close to our Credit History 101, we end with one of the most popular questions people ask: how long does it take to build credit history? Unfortunately, it tends to be the hardest one to answer.
Your timeline may be impacted by a number of different factors. Credit scoring models, existing entries in your file, and your ability to follow through on the habits we outlined today are just some of the things that determine how long it takes.
Your score is constantly changing, so you can’t afford to take a break from monitoring your finances.