What if you woke up one day with a huge three-digit number above your head? Would that make you believe that credit is important?
What if the number directly impacted the opportunities you were given?
What if you went to the bank and someone behind you with a larger number took out an identical loan as you did, but was offered a significantly less interest rate? Wouldn’t that be wild?
Although this may sound quite dystopian and a little wild, this happens every single day with our credit scores – the only difference is that our numbers aren’t visible to everyone around us and more often than not, we don’t even know our numbers. Could you tell me your score right now, off the top of your head? If you can’t tell me your score right now, then this article is for you.
BLUF: Credit scores are a critical element of personal finance. By creating an intentional, solid credit foundation based in knowledge and responsibility, you will be equipped to leverage credit to save on premiums and rates, while also earning sweet rewards!
What Is A Credit Score?
A credit score is a number between 300-to-850 that depicts a customer’s creditworthiness, or, in other words, a borrower’s ability to repay a debt. A credit score is based on your credit history: number of open accounts, total debt, repayment history, and more.
Why Your Credit Score is Important
FICOs and VantageScores are on a 300-to-850 scale. Oftentimes, you can find out your credit score for free through your banking institution. Other free and reputable sources include Credit Karma and Nerdwallet. I have the Credit Karma app and check it a few times per month to monitor any changes to my score, such as new credit inquiries.
If you started reading this article with no clue what your score is, please check in with one of these sources and come back – I’ll wait.
Welcome back. Now that you know roughly what your credit score is, let’s talk about why it’s important in more detail:
Credit scores are used by key industries, including insurance, housing, and utilities, to determine the worthiness of a potential customer. Insurers use credit scores to set premiums for auto and homeowners insurance. The higher the score, the lower the premium. If you’ve ever rented a home before, then you know landlords use credit scores as an integral part of the application process. Additionally, cell phone carriers offer the best cell phone plans to consumers with good or excellent credit.
Informa Research Services found that someone with FICO scores in the 620 range would pay $65,000 more on a $200,000 mortgage than someone with FICOs over 760. This is a substantial difference! On a five-year, $30,000 auto loan, the borrower with lower scores would pay $5,100 more. That’s 17% more than someone with excellent credit! Now that the fire underneath you is ignited to build a solid credit score, let’s explore how credit is built.
Ways to Build Credit
It’s important to note that credit is built over time and scores differ based on the scoring formula used and which of the three credit bureaus supplied the information. The three credit bureaus are Equifax, Experian, and Transunion. Experian and Equifax provide 16 different FICO credit scores to lenders, while TransUnion has 21. If you have ever financed a car and reviewed your credit report, you will see several numbers listed out, including the one they used to determine your creditworthiness.
The most popular way to build credit is to open your first credit card. Your first credit card could be a student credit card, secured credit card, or a fair credit card. Whichever type you choose, be sure to check out my previous article first: 5 key things to consider when getting your first credit card.
Good Credit Habits
As you start to build your credit score, it’s imperative to practice good credit habits. Here are some good credit habits to implement as you start your credit card journey:
- Paying your bills on time. Paying your bills on time ensures you’ll never miss a payment (score!) or incur interest (double score!).
- Paying balances in full. Paying your balances in full means you will not incur interest.
- Review your spending. My husband and I review our spending weekly to make sure that we’re staying on track with our financial goals.
- Keep credit utilization below 30% of the total available balance. Experts recommend keeping your credit utilization below 30%. This means you aren’t spending more than 30% of your total credit limit each month. For example, if your credit limit is $1,000, you want to keep your balance below $300 each month.
- Avoid closing old accounts. Closing old accounts can negatively impact your credit score, so keep them open to preserve your length of credit history.
Things to Avoid
Here are some habits to avoid:
- Not reviewing your monthly expenses. Sometimes, new card users get swipe happy and end up spending more than they thought they spent. It is critical to stay on top of your spending!
- Living outside of your means. Just like the point above, monitor your spending and ensure that you are spending an amount that is within budget and can be paid in full.
- Opening new credit cards often. This is a quick way to drop your score! New cards should be strategized and done over time to maximize your score and reward potential.
- Missing a payment. A single missed payment can knock more than 100 points off your score.
- Collections or a lawsuit judgment can dent your score. Keeping up with things like medical bills and defaulted cards prevents your account from going into collections.
- Not monitoring for identity theft. Identity left can completely ruin your credit score, so it’s important to monitor your report and ensure there are no odd lines of credit taken out in your name.
Credit is Important, What’s Next?
A healthy credit score offers consumers more affordable insurance premiums, lower interest rates, and so much more. By creating an intentional, solid credit foundation based in knowledge and responsibility, you will be equipped to leverage credit to save on premiums and rates, while also earning sweet rewards! What is next in your credit journey? What more would you like to know?