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Your Credit Score and You

Your Credit Score and You

Before you apply for any sort of credit--from unsecured debt (e.g., credit card debt), to collateralized debt such as a mortgage or car loan--you should be sure to know what your credit score is. A bad credit score can require you to pay higher interest rates or may even prevent you from getting certain types of credit.

With nationwide concern over mounting mortgage defaults, lenders are focusing carefully on credit scores. Therefore it is more important than ever for you to understand what a credit score is and how it can affect you.

What is Your Credit Score
Actually, you have more than one credit score. There are three major credit rating agencies in the U.S., and each calculates credit scores in a slightly different way. However, there are some common factors.

In order of importance, the following are leading elements of your credit score:

  • Previous credit performance--the extent to which you have paid your debts on time in the past, the most recent past being most heavily weighted
  • Current level of indebtedness--loans and credit card debt outstanding and amount of available credit used (being maxed out lowers your score)
  • Time credit has been in use--the longer the better
  • Number of Open Accounts--if you have many open sources of credit, you are considered a higher risk because your debt situation can change quickly
  • Pursuit of credit--actively pursuing multiple new sources of credit can be a red flag
How the some of the above affect your credit score can be a delicate balance. For example, having no debt and no credit cards is a bad thing--it means you have no credit history. On the other hand, too much existing debt and too many active credit cards are also a bad--it suggests that you are a default risk.

 

How This Affects You
A low credit score can mean paying higher interest rates on loans or on unsecured debt like credit cards, or it can even mean having your credit applications turned down. For people with bad credit, this can turn into a vicious cycle: high payments lead to more debt, which drives the credit rating lower; this means still more high payments, and more debt problems. Pretty soon, it may become difficult to avoid bankruptcy. It is important to seek debt relief strategies before it comes to that.

How You Can Improve Your Credit Score
Improving your credit score can help break that cycle. While it can take time to improve your history of credit use, there are some immediate steps you can take:

  • Be careful about applying for new credit--too much activity counts against you
  • Reduce the number of credit card accounts you have active
  • Work to pay down existing debt before taking on new debt

If you can't do this yourself, seek reputable credit counseling. Credit counseling can introduce you to a variety of debt relief options, and ultimately, help you avoid bankruptcy. One debt relief option is a debt management plan, which involves having a credit counselor help manage your finances. A debt management plan can be a rigorous form of debt relief, but it beats living with the high cost of a low credit score.

Sources:
The Street.com
Investopedia
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