Credit Worthiness – What's your score?
Channel: The Financial Literacy Course
Date: 2021-01-14

Have you ever lent money to a friend, only to have them forget about it? How did that change your perspective of them? In this lesson, we will explore what a credit score is and how lenders use that number when lending money.

Would you prefer to lend money to a friend who has borrowed from everyone they know, or a friend that has always promptly paid you back in the past?

Credit companies usually don't know us personally, so they use our credit score to determine our reputation and creditworthiness. In other words, they look at your credit history and habits to determine how likely it is that you will pay them back as promised, and if they trust you for a loan, your score will determine the terms of the loan. 

Creditors look at five main areas when judging your creditworthiness. 

Do you pay on time?
How much of your available credit do you use?
How long have you had these credits?
Have you recently opened a new credit?
Can you handle different types of debt?
The most significant factor in your creditworthiness score is how you've managed finances in the past. If you've never been late or missed a payment, your score will be significantly higher than those who haven't kept up. Filing for bankruptcy, having a debt go to collections, or being evicted can destroy your credit score for years.

Another critical factor in your credit score depends on how much of your credit you use... even if you pay the full balance each month.

Take Parker and Birtha as an example...

Both people have the same credit card with a limit of $2,000, and both always pay it off on time before the due date. Parker only uses $500 of his credit, while Birtha uses $1,900. Since Parker uses less of this available credit, he gets a higher credit score.

Maxing out a credit card can lower your score enough to move you from good to fair, or from fair to bad. [meter going down]

Another element that factors into your credit score is the length or age of your credit. The longer you spend in good faith with your credit, the better this part will perform.

Just be warned that opening too many new loans or credit cards will give lenders the impression that you are under financial distress. 

Your credit mix also plays a small role in your score. Credit companies look to see if you have a history with both Installment and Revolving types of debts.

What can you do to improve your creditworthiness?