The methods for calculating credit scores can be difficult to understand.
The good news for consumers is that it isn't necessary to know the nitty-gritty details that go into a credit-scoring algorithm. Once you understand the basics of credit and why it matters, you'll have the knowledge you need to make smart decisions that may help improve your credit score.
Your credit score starts with you: whether you're paying your bills as agreed, how many credit accounts you have, and what kind of accounts those are. According to the Consumer Financial Protection Bureau, or CFPB, your credit score will also reflect how much of your available credit you're using, how old your accounts are, and whether you've had a debt in collections, foreclosure, or bankruptcy.
Lenders, banks, and financial companies you do business with share this data about your account activity with the three major credit bureaus, Experian, Equifax, and TransUnion, which track and maintain your credit records.
Why you should care about credit
Some debt-averse consumers have the attitude that credit scores only matter for those who choose to use credit. But this couldn't be further from the truth. Credit histories are often used as a de facto measuring tool for sizing up consumers and are used by many entities outside of lending institutions and credit card issuers.
As Bill Pratt, author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit, Debt & Ca$h, tells Bankrate.com, a strong credit score "matters more in this generation than it did in past generations."
The CFPB explains that cable companies, Internet servicers, mobile phone providers, utility companies, apartment complexes, insurers, and employers alike may contact the "Big Three" bureaus to pull your credit information to evaluate whether or not to enter into a contract with you.
This also means that your credit score can affect how much you pay for homeowners insurance, auto insurance, or other services.
In short, having good credit means saving money on many things-not just on loan interest rates.
Why personal loans are credit builders
"A personal loan can be a good tool for building credit. As long as you pay your personal loan on time each month, then it should build a positive credit reference that can help you build or rebuild credit," says Gerri Detweiler, director of Consumer Education at Credit.com.
"Unlike credit cards, personal loans are installment debt, so the utilization ratio isn't considered. Transferring a revolving debt into a personal loan could give your credit a boost," adds Detweiler.
The utilization ratio, which factors in how close you are to your credit card limit, is a major factor in generating credit scores. The closer you get to maxing out your plastic, the lower your credit score will be. Since utilization ratios are inherent only to credit cards, moving card debt onto a personal credit line causes the ratio to drop, which can help raise your credit score.
The other major credit-scoring factor
For all its credit-scoring merits, a personal loan won't help you build credit if you're not making timely payments. If you're not paying your bills on time, your credit score will reflect it.
As Michelle Singletary emphasizes in an article in The Washington Post, "Paying your bills on time is the No. 1 way to fix your credit. Every debt. Every month. On time."
FICO shares in its credit-score breakdown that 35 percent of a FICO score is determined by payment history.
Late payments or missing payments will ding your credit score, but, on the flipside, consistently building a good track record of on-time payments is the surest way to improve your credit over time.
Obtaining a personal loan can be a solid first step in building credit, but making on-time loan payments is just as important to help ensure that your credit continues to improve.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of OneMain. The information in this article is provided for education and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial, legal or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else. The author was compensated by OneMain for this post.