The World of Credit Scores

In my first post, I touched on how exploring the credit system fueled my interest in finance. Here, I’ll delve into my personal journey of uncovering the ins and outs of how credit works.

Many around me believed credit cards were a gateway to debt, but I understood that this wasn’t the case. To build a solid credit score, having a credit card was essential. A good credit score isn’t just a luxury—it’s crucial for renting a home, financing a car, setting up home utilities, and purchasing a home. While it's possible to apply for loans or rent an apartment with less-than-stellar credit, you might face higher costs or decreased chances of approval. For instance, a landlord might reject your application or ask for a larger deposit due to the perceived risk.

Before you apply for your first credit account, it’s important to understand what makes up a credit score:

1. Payment History (35%): This reflects if you’re making your payments on time. This factor is the bigger chunk of the pie; missing payments can significantly impact your score, so it’s crucial to stay on top of them.

2. Utilization Ratio (30%): This ratio shows how much of your available credit you’re using. For example, if you have a $1,000 limit and a $500 balance, your utilization ratio is 50%. A good practice is to always pay off your credit cards in full but if that’s not possible, at least maintain your overall ratio below 20%.

3. Length of Credit History (15%): This refers to how long your credit accounts have been active. Older accounts generally contribute positively to your score. Note that credit cards with no activity might close automatically after six months of dormancy.

4. Credit Mix (10%): This involves the variety of credit types you have, such as credit cards, auto loans, and student loans. A diverse credit mix can positively impact your score.

5. New Credit (10%): This is the infamous “te van correr tu credito.” When you apply for new credit, a hard inquiry is made, which can slightly lower your score. It’s wise to manage how frequently you open new accounts. Consider checking if you can get a soft inquiry or pre-approval before applying to gauge your chances of approval.

Best Practices:

1. Set Your Credit Cards on Auto-Pay: This helps ensure you don’t miss a payment.

2. Pay Off Balances in Full Each Month: This practice helps you avoid interest charges and fosters good financial habits. If you struggle to pay off your balance in full, use your credit card sparingly, perhaps just for specific expenses like gas or subscriptions.

3. Don’t close older accounts. Keeping older accounts open can positively impact your credit history length.

4. Monitor Your Credit Score Regularly: Use apps like Credit Karma or Experian to keep track of your credit health and catch any issues early.

Read more on how to apply for your first credit card here.

This material is intended for educational purposes only. The information and opinions expressed on any websites linked in this material are from unaffiliated third parties. While they are deemed trusted and reliable, we cannot guarantee their accuracy.