Your Credit Score – The Least Understood Aspect of Your Finances
Investments and insurance can get complicated, but what tends to really get people’s eye to glaze over is their credit score. You know that seemingly arbitrary three digit number (ranging from 301 – 850) that dictates whether or not you can get a loan? We certainly don’t plan to argue that knowing and understanding your credit score is anywhere near sexy, however, it is a critical and oftentimes overlooked component of your financial health. Think of your credit score like your blood pressure reading for your financial health.
Financial institutions across the country use credit scores to gauge whether or not you are financially responsible enough to be lent money. This could include a mortgage loan, credit card, or even a business loan for that start-up you’ve always wanted to launch. Whatever the form of credit you are hoping to take on your credit score will play a critical role in getting approved by the lender and ultimately it will impact your interest rate.
For example, if you have a poor credit score (poor 600-649, bad below 600) a bank might make the loan to you, but the interest rate you are forced to pay could be significantly higher than what it would’ve been had you had a more sparkly clean credit history.
Okay, So How Does It work
In the land of credit scores, FICO, is king. Founded in 1956 the FICO Score is the primary measure of consumer credit risk and while the complexities of the system are a closely held secret, FICO provides a high level overview of the five critical aspects that go into your FICO Score.
- Payment history (35%): The most critical aspect of your credit score is simply the history of your responsible on-time payments (or lack thereof). When it comes to your credit score, FICO believes that a history of on-time payments is an indicator of your likelihood to continue into the future. For those young professionals just starting out in their careers it is critical to begin establishing a credit history by making on time student loan payments, credit card payments, and any other type of outstanding payments you might have.
- Debt total (30%): This is simply the total amount of debt owed both in revolving lines of credit (think credit cards) and installment loans (think mortgage loan or fixed amount). FICO considers borrowers who frequently borrow up to their maximum more risky than those whole only use a healthy amount of their available credit. The general rule of thumb is to utilize only 30% of your available credit.
- Length of credit history (15%): This is the hardest component of your credit score to perfect as a young professional, because you likely don’t have a ten or twenty year track record of payments. If you are hoping to buy a home in the future this is why opening up a credit card and paying it off every month can be so advantageous because it will begin to establish a positive credit history.
- New Credit (10%): Your credit score is a delicate game. Taking too much new credit can signal red flags and negatively impact your credit score. If someone opens four new credit cards in one month FICO looks at that and wonders if you are facing some financial issues that could jeopardize your ability to pay your loan payments on time.
- Credit Mix (10%): The last component of the FICO Score is rather vague, but it essentially means that having a diverse track record of credit history is valuable to your score. For example, having a history of paying off both a few credit cards, a mortgage loan, and maybe some student loans is a lot better than just paying off one credit card each month.
Give Your Credit an Annual Physical
You go to the doctor once a year for a physical, so why not at the very least do the same with your credit score? To do this there a number of free options that you can use to get your credit physical. To get an updated credit report you can visit www.annualcreditreport.com for a free copy of your credit history. You should review your report at least annually to ensure that there are no errors or signs of fraud that could jeopardize your credit score.
To check your actual credit score you can visit one of the various free sites online such as www.credit.com or www.creditkarma.com. Both of these sites are legitimate and are free in large part due to the advertising on the sites. Tip: don’t be lured into one of the credit card offers on the site. Another thing to consider is that credit cards are increasingly offering free FICO Scores with their cards which is an awesome perk that allows you to frequently monitor your score.
Tips for Dominating Your Credit Score
Despite the underlying complexity of your credit score there a number of ways you can work to improve your score if it isn’t yet pristine (750+) or to simply keep it in good order if you’ve done so already. Here’s a quick list of things to do to ensure your credit score stays top of its class.
- Always pay on time! Consistently making on time payments will positively impact your credit score. If you struggle with forgetting to make payments on time, be sure to turn on autopay to ensure that even small balances don’t go unpaid from month to month.
- Be aware of what percentage of your credit balance you are using. For example, if you have a $10,000 available credit with one of your cards be sure to try and only use roughly 30% of the available balance from month to month. Remember using too much of your credit can be seen as a red flag when it comes to your credit score.
- Like fine wine, age matters when it comes to your credit history, so be sure to avoid closing out credit cards that you’ve held for a long period of time. That established track record with a particular card does wonders for your credit score.
- Excess credit isn’t a good thing. Having enough lines of credit to establish a strong track record of on time payment is important, but having too many can also be detrimental to your score. Avoid opening up credit scores just to open up credit cards, especially those that come with some type of gift.
- Lastly, be sure to pay any outstanding debts. Any money in collections or debt payments that are late negatively impact your credit score as long as they remain outstanding, so be sure to clean these items up right away to avoid further hurting your credit score.
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