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How a Poor Credit Score Could Affect Your Everyday Life

Credit Score Determines Your Financial Credibility

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Have you ever wondered why your loan application was denied or why your insurance premiums are so high despite your being in good health? It could be due to a low credit score. Nowadays, landlords, insurance companies and loan providers can simply check your credit score to determine whether you will be able to pay your bills on time.

A credit score sums up your financial credibility by considering your spending habits, repayment history, and credit mix (credit card or mortgage). A landlord could deny you accommodation on the basis of a poor credit score even if you have a high income.

Even worse, a poor credit profile could affect your job opportunities. Most employers conduct a credit review during background checks to see if a person has high debts or a history of bankruptcy and poor repayment.

Additionally, the pandemic has led many Americans to rack up debt, dive into retirement funds and face evictions and job losses. As such, it may be helpful to understand what good and poor credit scores are, what affects credit scores, who decides them and how they are reported to credit bureaus.

Credit Score, Credit Bureaus and Credit Cards

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Have you ever missed credit card payment deadlines or sometimes made very late payments? Aside from the high late fees you pay as a consequence, credit card issuers might also report credit card repayments to three major credit bureaus: Equifax, Experian and TransUnion. While timely repayments could boost your credit score, late payments may cost you significant points.

Credit card debt plays a significant part in U.S. household debts. In addition, the credit card delinquency rate of 1.89 percent in the first quarter 2021 could be linked with the exorbitant late fees and interest rates.

Fair Isaac Corporation (FICO) is a 64-year old data analytics company that created the FICO series model, an algorithm widely used today by credit bureaus to generate credit scores. According to its official website, 90 percent of online lenders check your FICO 8 credit score while reviewing loan and credit card applications. The FICO series has multiple models like the FICO 2 scores, which auto lenders use to extend auto loans, whereas mortgage lenders review the FICO 5 credit scores. For credit card and personal loan applications, creditors are likely to check your FICO 8 credit score.

The FICO scale ranges from 300 to 850. If you have a high score, you would be considered a financially credible person with a higher chance of securing loans. Those with a poor credit score might secure loans at very high interest rates or not get approved at all.

To break it down, here's how FICO weighs various aspects of your finances to calculate your credit score:

  • Repayment history: Missed payments reported to the credit bureaus might not go well for your credit score. In fact, a poor repayment history could single-handedly undermine your creditworthiness. A lender wants to be confident that you can repay your debt on time, so any doubts on your capability to handle money wisely could lead to rejections. In addition, reports of defaulting on credit cards or personal debt payments could stay on your credit profile for up to six years.
  • Credit utilization rate: Suppose you have a credit card with a $10,000 credit limit on which you have already spent a total of $3,000. So, your current outstanding balance would be $3,000, with the option to spend another $7,000. To calculate credit utilization, simply divide the outstanding balance by your total credit limit and then multiply it by 100. In this case, that would be 30 percent. Credit utilization indicates the debt you carry, which lenders might check to see if you will be able to repay without defaulting. If your credit utilization is 90 percent, lenders might consider you are having trouble managing your monthly budget. Any additional credit to existing loans could make the situation even worse.
  • Length of your credit history: This is an intrinsic factor that could work in your favor over time. The FICO models will consider the age of your credit profile and how long you've been using credit from lenders to determine your experience in dealing with finances. As such, an older credit account could lead to a high credit score even if you are not using the account.
  • New credit: Even if you are good at handling money, frequently applying for loans and credit cards might give lenders the impression that you could be a high-risk borrower. When you apply for a credit card, personal loan, or mortgage, the bank/issuer will go for a hard pull on your credit profile to check your spending habits, repayment patterns and current debt balance before making a decision. While a single hard pull may or may not affect your credit score, multiple hard inquiries could significantly tank your credit score. On the other hand, a soft pull inquiry is when you check your credit score or a company does as a part of background checks, which does not lead to any loss in credit points. In contrast, hard inquiries can stay up to two years on your credit profile. Additionally, if you have too many inquiries on your report over a short time, lenders might be hesitant to offer you a loan.
  • Credit mix: The FICO algorithm will gauge how good you are at handling a mix of credit accounts like credit cards, loans and mortgages. If you make timely payments towards loans and mortgages, lenders might perceive you as a financially responsible client as well.

How to Check Your Credit Score for Free and Remove Incorrect Negative Records

Even though your credit score may affect your shelter, job and personal aspirations like buying a house or car, many have yet to check their scores.

The first step to building your credit score is to find out your current score and look for accounts that have been negatively impacting your credit report. You might come across incorrect entries like late payment remarks, for example, even if you paid on time. Before prioritizing your current loans, it would be crucial to remove any false negative feedback that could remain on your record for years.

Credit Karma, one of the largest financial companies with a user base of over 110 million people, offers online services that you could use to fetch your credit report for free. You may use its app or desktop platform to sign up and check your credit score from TransUnion and Experian. The free account comes with credit and ID monitoring services to keep you updated on new entries to your credit report and changing credit scores. This way, you will stay in the loop and learn about any inconsistencies early on.

While it might take some time to rebuild your credit score, prioritizing your debts and timely repayments could help immensely.

Check your credit score for free today.

The contents of this article is for informational purposes only and does not constitute any financial or investment advice. It's important to perform your own research and consider seeking advice from an independent financial professional before making any banking or investment decisions.

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