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Most people do not know their credit score………………..
much less understand what credit really is or even the credit scoring system until they decide to make a major purchase (i.e. buy a home, a car, apply for a personal loan or credit card, etc.).
While I do not like to use credit to purchase things, your credit score dictates a lot about your financial life. Whether you like it or not, credit is a HUGE part of your financial life.
I talk a lot about this in the article below:
Credit – Your Lifeline To Financial Success
And I’m not alone.
Society has become increasingly dependent on credit to make purchases and to dictate their financial decisions.
In fact, today’s economy runs primarily on credit. From the loans being made to the investments being traded on Wall Street to the currency being printed by governments, credit runs our financial lives.
Today’s article talks about what is credit, what makes up a good credit score, why good credit is needed, the benefits, and so much more!
I hope you enjoy today’s article!
What Are The Basics Of Credit?
Having credit means having the ability to buy something now and pay for it later. Think of credit as having the permission to give someone an IOU whenever you want to.
But there’s a catch………
Just because you can buy now and pay later doesn’t give you full autonomy to NEVER pay the IOU back.
Banks and lending institutions charge you interest on the amount borrowed for 2 reasons: to earn a little money off you and to give you incentive to pay the amount back in full as soon as possible.
Let’s face it. If you don’t pay the money back, they are more than happy to keep charging you interest to the point where you default.
So it benefits you to pay that money back as soon as possible.
Remember it’s a loan NOT a gift.
In general, credit availability is based on 2 types of credit: installment loans and revolving credit.
Installment loans are loans where you pay off the purchase in set amounts or installments each month.
Examples of installment loan are a mortgage, auto loans, and student loans.
Revolving credit is a line of credit you can keep using after paying it off. Purchases can be made using revolving credit so long as the balance stays under the credit limit.
Examples of revolving credit are credit cards or a home equity line of credit (HELOC).
Lastly, there is your credit score.
A credit score is a scoring system used to rate your credit worthiness and helps dictate the interest rate and loan amount you are eligible for.
The most common type of credit score is the Fair Isaac Corporation (FICO) score.
A FICO score ranges from 300 to 850. The higher the number, the better your credit rating and the more likely you will be approved for new credit or offered the best interest rate.
FICO scores fall into the following ranges and is used to determine your credit rating:
- Poor Credit: 300-579
- Fair Credit: 580-669
- Good Credit: 670-739
- Very Good Credit: 740-799
- Excellent Credit: 800-850
The 3 major consumer reporting agencies (Experian, TransUnion, Equifax) use FICO score to report your credit rating and each provide a free credit report annually that you can request.
But why do you need to care about your credit score anyways?
Because it has a lot of perks for your entire life.
Benefits Of Good Credit Score
There are a ton of benefits to having a good credit score. We’ll cover some of those next.
Easier To Get A Job
Your employer can conduct credit report checks during the hiring process.
Employers are running credit checks to see whether you can be trusted with company finances and if you are responsible in general.
For example, a prospective employer may think your level of debt is too high for the salary being offered. Also for executive or finance-related positions, an employer may run a credit check before giving a promotion.
If you have a history of being financially irresponsible, you may run into problems finding work.
In other words, a good credit score could be the difference between being hired, getting the raise you think you deserve, or stuck on the unemployment line.
Lower Interest Rates
People with good credit are often offered lower interest rates.
Paying less in interest on your debt can save you a lot of money over time.
The reason is that lenders use higher rates to protect themselves when the people they lend to cannot pay.
Don’t believe me? Curious how much it can save? Here is an example.
According to Lexington Law, a person with a 640 credit score will typically receive a credit card interest rate of between 16.5 and 20.5 percent.
On the other hand, a person with excellent credit (score of 800 or more) can receive a credit card for about 13.5 percent interest.
If you carry a balance on your credit cards (something I do NOT recommend), it can add up to literally hundreds of dollars a year in interest.
Easier Credit Approval
If you have good credit then banks, lenders, and insurance companies are more likely to (and more quickly) approve your credit applications.
This means when you apply for home/auto insurance, mortgages, credit cards, and personal loans, you not only will be accepted but will probably spend less time waiting to hear back on the results.
In fact, if you have excellent credit, lenders will be reaching out TO YOU requesting your business.
You see, lending institutions need your business to stay solvent, BUT they cannot take on unnecessary risk. Your excellent credit score is the perfect solution to their problem! 😊
Now the $10,000 question: How do I calculate my credit score?
We’ll cover that topic next!
How To Calculate Your Credit Score
Before we dive any deeper, you need to understand what impacts your credit score and by how much.
Here is how your FICO score is calculated:
- Payment History (35% of score) – Your payment history is THE most important factor impacting your FICO score. It shows how you managed debt over time. If you miss a single payment, it has a HUGE impact on your credit score.
- Amount Owed (30% of score) – This factor refers to how much you owe on ALL your lines of credit. It’s best to keep revolving balances (i.e. credit cards) under 30% utilized for each credit card AND on all credit cards combined. For example, if you have a credit card with a $15,000 credit limit, ensure you never use more than $4,500 of that limit to optimize your credit score. If your combined credit limit of all credit cards is $30,000, use no more than $9,000 of the total credit limit.
- Credit History Length (15% of score) – This refers to how long you’ve held credit accounts. The longer the better. Your score calculates this average age by taking each line of credit and the length it has been open, summing it, and then divide it up by the number of credit lines you have open.
- Credit Mix (10% of score) – It measures how many different types of credit lines you have open. If you only have a credit card open, your score will be low. However, if you have a mortgage, HELOC, car loan, student loan, AND a credit card open, your score will be higher.
- New Credit (10% of score) – Having new credit line open is ok but having too many open at once is a giant red flag to your FICO score that you may be a credit risk.
If you want to understand more about what impacts your FICO check out this article I wrote:
If not nurtured properly, these 5 things can impact your financial life for years to come. I know from experience.
Several years ago, my wife and I were doing our best to pay our children’s medical bills, but it was a Grand Canyon-sized hole we dug ourselves.
Despite our best efforts, I’ll admit it and am not proud to say it, some of our bills lapsed and went to collections. After a lot of hard work, effort, and help from a friend who was a financial planner, we developed a plan to get out of our debt.
While we worked the plan, our credit took a hit for a few years. It used to be excellent, but now was just fair.
Several years after working our plan, our credit is back up in the 800+ range!
How did we do it? By following the 5 tips I’ll go through next.
5 Tips To Improve Your Credit Score TODAY
If your score is not where you want it to be, these 5 tips will give you the boost you need and fast!
Never Miss A Payment
If 35% of your FICO score is based on your ability to make a payment, then what is the most logical step?….. don’t miss a payment!
I know it sounds simple, but if you struggle with keeping track of your bills and when payments are due check out my FREE budget template!
Budget Template (Go To Bottom Of Page)
Once you start tracking the due dates for all your lines of credit, paying them gets so much easier!
If you know you might be late with a payment, just call up the credit agency and ask for an extension until TBC date. If you are honest and sincere with them THEN follow through as promised, you’ll be surprised what you can negotiate.
Also if you are waiting until your next pay period to make a HUGE payment on your credit card, don’t stress about it. Just pay the minimum by the due date and then make an extra payment when your next paycheck arrives! How beautiful is that? 😊
Max Out Credit Amount AND Keep Balance Low
The next big factor in determining your FICO score is credit utilization. In other words, it’s the ratio of how much debt you have versus how much debt you are allowed to have.
To minimize the credit utilization rate, first see if you have extra money to start making a bigger payment on the debt.
If you need a side hustle to earn extra cash, I wrote an article on some easy ways you can earn side cash TODAY!
10 Easy Ways To Earn $1,000 A Month
Once you start making larger debt payments, next try this.
It will sound counter-intuitive but hear me out.
Call up each credit card company and ask for your credit limit to be increased by as much as they will allow!
Remember, your credit utilization rate is determined by how much available credit is used. If you increase the credit limit, you will lower the credit utilization rate (Remember, lower is GOOD!).
Genius, right? It’s using the credit card company’s strategy to your advantage.
Do your best to get the utilization rate down below 30% as soon as possible then work as fast as you can to lower it down to under 10% (that is the sweet spot for achieving excellent credit score rating).
Keep Old Credit Accounts OPEN
When you start to payoff some of those loans and credit cards, here is another thing that seems counter-intuitive but works great.
When that balance is finally paid off, keep the account open even if you do not plan to ever use it again.
The reason is your credit account has history that the credit agencies track. The longer you keep it open, the more responsible you look at managing debt.
As you open a new account and after it ages for a couple of years, THEN close one of the old accounts you do not use.
This way, you maximize your credit score and minimize your debt! 😊
Improve Your Credit Mix
To show that you are good at managing debt, credit agencies want to see you have several different types of credit open.
If you only have a credit card and student loan open, that is not a good mix yet.
Once you buy a house and a newer model used car, your credit mix will start to improve.
What if you do not have enough money to buy a house? Try taking out a personal loan from a bank.
You can take out a personal loan for virtually anything: a new bike, jet ski, consolidate personal debt (i.e. heavy debt on credit cards), etc.
Pay this loan back in a timely manner and watch your credit score soar!
Spread Out New Credit Applications
Opening too many new credit lines in a short amount of time is a recipe for disaster with your credit score.
Odds on, you’ll be dinged as a credit risk for taking on too much all at one.
Instead do the opposite: spread out the applications.
Open a new line of credit every 12-18 months. This will show the credit agencies you as consistent and reliable.
Taking on too much at once, makes you seem like a risk and credit agencies HATE taking on risk.
Also if shopping for a home and a new car at the same time, it’s ok just make sure you spread out the request by several weeks or even months to avoid influencing your credit score.
Bonus
Here is a bonus tip: Make sure to regularly check your credit score.
Watch out: Checking it too frequently will ding your credit score and we don’t want that do we? 😊
You are legally allowed to receive a free credit report once a year from each of the 3 main credit agencies: Equifax, Experian, and TransUnion.
To take full advantage of this ability to check your score without dinging your credit, just request a copy from one of the crediting agencies every 4 months.
It’s a trick I have used to keep up on my credit score without dinging it.
Lastly, if you notice an error, call the agency and place a dispute against it. These errors may seem trivial but can cost you hundreds of dollars a year in unnecessary interest payments.
After all, it would be a shame to have all that effort be wasted like that, wouldn’t it? Lol 😊
Conclusion
Your credit score impacts your financial well-being and ability to achieve long-term financial goals.
By regularly increasing your financial literacy, improving your credit score, and checking your credit report for errors, you’ll know what areas to work on to develop a strong credit profile.
Remember, credit is part of your financial power and your lifeline to financial success.
It helps you to receive the things you need now like a car, a house, cheap insurance, or a loan based on your ability to keep your promises now to pay them back later.
Since credit scores are such an integral part of our financial lives, it pays to keep track of your credit score and understand how your actions can affect it.
Plus, society places such dependency on credit that a good credit score also demonstrates your financial character and integrity to lending institutions.
Credit scores, if used properly, are a great financial tool.
But whether that tool is a lever or a hammer depends on how good you are utilizing it and is totally up to you.
Following the 5 pieces of advice I’ve given will get you on the right track to financial success.
Ensure that this tool is used as a lever to brighten your future and allow you to appreciate the fruits of your labor.
Now go make it happen!
Live The Life You Love, Want, And Deserve! 😊
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So, what do you think about today’s article? Think it can work for you? I’d love to hear your comments and reaction. Send me an email and let’s chat!
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