A credit score is a number that determines a consumer’s creditworthiness and helps lenders assess if lending to that customer is secure for them. Borrowers with less-than-ideal credit scores typically have lower chances of getting approved for a loan, and less financial flexibility as opposed to those with an outstanding credit score. If a borrower has poor credit, it’s generally wise for them to take steps to improve credit score.
There are many techniques that borrowers may use to improve their credit score. This article will cover the essential techniques that may help you achieve financial freedom by boosting credit ratings.
Understanding Your Credit Score
A credit score is essentially a number indicating a borrower’s or a business’s financial health. The credit score number is a measure of the borrower’s entire debt and credit history.
Lenders usually use a credit rating system to determine if a borrower applying for funds is suitable for a loan. The higher an applicant’s credit score, the lower the risk they pose to a lender. Thus, they can be considered a low-risk applicant. Such borrowers might have a better chance of getting approved for a loan.
In Australia, credit scores generally range from excellent, good, fair, and poor. Credit reporting agencies like Equifax, Experian, and Illion calculate and report credit scores. Each credit reporting agency calculates scores in different ways, meaning there is a slight variation between credit scores.
Despite this, according to Equifax, a credit score above 660 is considered good, and a score of 853 or higher is excellent. The components that make up a credit score are typically the following:
- Payment history
- Credit utilisation
- Credit age
- Credit mix
- New credit
Essential Techniques To Boost Your Credit Score
Pay Bills On Time
Maintaining timely utility and phone bill payments might also raise a borrower’s credit score. One of the more serious black marks that can appear on a credit report is a default. Defaults are outstanding bills.
Bills that are $150 or more and those overdue by 60 days stay as defaults visible on a credit report for five years, even after being paid off. Defaults can negatively impact borrowers’ chances of getting approved for a loan, which is why it’s crucial to avoid having any on a credit report.
In order to ensure that bills do not result in a default, you may set up automatic payments to remain on top of unpaid bills.
Keep Credit Utilisation Low
Another essential technique for improving credit scores is to keep credit utilisation low. Credit utilisation represents how much credit the borrower has used in relation to the remaining available for use.
In other words, it’s the ratio of their credit card balances to their credit limits. Ideally, credit utilisation should be under 30%. By keeping credit utilisation low, borrowers may ensure they don’t max out their limits and have space for additional charges.
Avoid Opening Too Many New Accounts
When an individual or a business applies for a new loan and the lenders request to review their credit report as part of the application process, it’ll be recorded in their credit report as a hard inquiry. This may affect their credit score, which is why it’s generally wise to avoid opening too many new accounts.
For instance, when a lender does a credit check on an applicant and sees that they have applied for multiple credits within a short period, it may be a red flag for them.
Pay Off Debt Strategically
Having a track record of reliable and timely payments might help build credit. Also, failure to make repayments may be reported in the credit report and may result in a lower credit score.
In order to improve credit score, it may be helpful to employ specific strategies when repaying debt, like a snowball or a debt avalanche method. The debt snowball method refers to paying off the smallest debts first, which helps build momentum by snowballing payments as each debt is paid off.
In contrast, the debt avalanche method involves paying off multiple debts based on interest rates. With the debt avalanche method, paying off starts from the highest-rate debt first. This saves the person paying off the most money in interest over time.
Diversify Your Credit Mix
Lastly, there are benefits to having a mix of credit types, including different loans, credit cards, etc. Managing a mix of credit types can show to lenders that the applicant can manage credit responsibly.
However, the borrower has to be capable of paying off the mix of credits on time. Otherwise, instead of improving their credit rating, they may lower it.
The Long-Term Impact Of A High Credit Score
Businesses and individuals with solid credit scores have more flexibility in financial decision-making, which contributes to financial freedom. Good credit score rating provides many financial benefits to the borrowers, including:
- Lower interest rates
- Better chances for loan approvals
- Higher credit limits
Common Mistakes To Avoid When Building Credit
- Overextending credit: Overextension occurs when a borrower has more debt than they can repay and goes over their credit limit. This may result in lower credit scores, additional fees, and declined transactions.
- Closing old credit accounts prematurely: Old accounts, especially paid-off ones, should remain open as they improve credit score and remain on the credit report.
- Making minimum payments only: Paying off as much as you are capable of instead of only making minimum payments may help improve credit score faster.
Frequently Asked Questions
Why is the credit score important for financial freedom?
Having a good credit score is essential as it improves borrowers’ chances of getting approved for loans. Not only that, but the higher the credit score of an applicant, the better the rates, terms, and deals on their loans.
How often should I check my credit report?
Typically, every Australian citizen has a right to get a copy of their credit report for free every three months. It’s generally a good idea to get a copy at least once a year so you can see if your credit rating has improved.
Conclusion
By incorporating the above-mentioned essential techniques, borrowers can manage their credit effectively, reduce debt, and thus, improve their credit score.
A high credit score can showcase to lenders that a borrower is a reliable candidate and boost their chances of getting approved for a loan. Moreover, high credit scores may help borrowers get offered loan deals with better interest rates and terms.
This financial advantage not only makes large purchases more affordable, but it also enables individuals to access opportunities that can lead to long-term financial stability and, ultimately, financial freedom.