Credit: the provision of money, goods or services with the expectation of future payment
As the mid-year is upon us, don’t let your savvy savings streak go on holiday. Now is the time to keep the momentum going or, even more importantly, to give a stalled savings strategy a much-needed, healthy jumpstart. Let’s revisit a misunderstood and often-overlooked financial vehicle that can either accelerate your personal wealth accumulation or put the brakes on it completely: the credit score.
You probably visit your family physician once a year for a “well check.” These annual exams give your doctor insights into your general health, which may be used to recommend therapies or changes to existing medications and other health interventions.
Well, think of the credit score as the results of a broad examination or evaluation of your financial health and “creditworthiness,” or how attractive you are as a borrower to a would-be lender. The credit score, in turn, provides considerable insights into your ability to consistently and fully pay your debts and financial obligations on time, as well as your debt load.
Your credit score is largely derived from information that falls into one of the following categories:
Time (length of credit history)
Credit composition (types of credit)
Far and away, the first two categories make up the biggest chunk of the score. At 65%, consistent payments and debt load carry the heaviest “weight” when determining one’s score. The balance of the score is spread over the other three categories, at 15%, 10% and 10%, respectively.
Credit score “ranges”
Each individual’s credit score is a three-digit number. Like the scores from your schooldays -- tests, pop quizzes or your GPA -- you want to shoot for a higher number here. The greater the figure, the more favorable the credit score is to you and, potentially, to so many aspects of your life (we’ll get into that more later).
Equifax, Experian and TransUnion represent the “big three” credit reporting agencies. The FICO® Score accounts for information from each of these main credit bureaus. So, FICO® is considered to be a “consolidated view” of how the credit-holder repays their debts. It is reportedly used by upwards of 90% of lenders when determining whether or not to approve an applicant for a loan, credit card, lease, or other form of financing and credit. Largely, credit scores are broken down into the following ranges (from “poor” to “excellent”):
Poor – 300 to 579
Fair – 580 to 669
Good – 670 to 739
Very good – 740 to 799
Excellent – 800 to 850
Why does all of this matter?
This may seem like an unassuming three-digit number. However, this score is one of the most powerful personal “badges” that you will carry with you throughout your life. It is likely the closest thing we, Stateside, will have for some time to the credit system popularized in the dystopian series Black Mirror -- due to the big, far-reaching effects of this one little number. Lenders want to account for their prospective borrowers’ habits, behaviors and overall ability to handle their “financial house.” It is a form of risk management; they want to know how risky it will be to do business with you.
Now, that score will likely flux as you build your credit. And it better flux or trend upward. Here’s why … and some of these impacts may surprise you …
A low score will cost you $$$$. In addition to banks and credit card companies, many subscription services run a credit check. So, you may not qualify for the mobile phone plan of your choice, or it may cost you more in premiums and monthly payments for insurance or basic services, such as utilities. Since you are deemed a “risk,” the service providers can tack on additional fees and charge you more for the same (or inferior) product or offering as your friend with a good score who is paying far less per month.
You may have a hard time getting a loan. Period. If your score is low enough, you may have to find a way to pay for that car with cash, or by dipping into your savings, which you really don’t want to do (partly, due to the penalties associated with taking monies out of certain retirement accounts). In addition to keeping you from obtaining day-to-day life needs, an unfavorable score can stand in the way of your starting and/or growing your own business. In other words, it can have a considerable, adverse aspirational effect.
Good scores open doors (to your dream home). How low does it go? Well, here again, if the score is low enough, you will likely need to enlist a roommate with very good credit, or seek out a credit-worthy co-signer. After all, landlords want to have the assurance that their tenants will pay every month, right on time, month in and month out. This additional help from a credit-worthy loved one may also be necessary for young professionals who are just starting out and have yet to establish a credit history. When the time comes to buy, an unfavorable score can prevent you from getting the property that you want to own – or it will cost you significantly more over the long haul (because you will not qualify for a lower interest rate on your mortgage). Additionally, you may need to consider forking out far more dough for a down payment if the scenario here sounds like you.
Good scores open doors (to your dream job). There are many desirable career paths and positions out there that may involve handling monies, or sensitive personal data and information. So, it stands to reason that a variety of government and finance jobs will consider your credit history and elements such as egregious debts outstanding when evaluating your worthiness for the job. Even applicants for positions that are not “high-security” or finance-heavy may be subject to background checks that include a credit check.
Additionally, when speaking about the direct and indirect costs of having a low credit score, to pay for something you really need, desperation may set in. You may be more susceptible to payday lending and other “no credit check” lenders that only further put you into a financial hole due to exorbitant fees.
What to do next There are many myths that plague the credit score and management process. For starters, it is important to know that each one of us is eligible to request a free credit report every year from each of the three primary credit bureaus. Start here. After all, you cannot improve or address what you do not know. Once you have accessed your report, take a good look at it. It’s estimated that one in every five people have an error in at least one of their credit reports. This error could be adversely affecting your score, costing you money and making the process of getting everything from a phone to a car to a house a daunting affair.
The above CFPB link also has information on what to do when you find an error in your report. Haven’t found any errors? Good! You may still be less-than-thrilled about your score. Or, there may be wiggle-room to take your score from good to great. We encourage you to go through each of the areas that are truly used to arrive at the credit score number. From there, you may zero in on opportunities to boost those digits. These areas include:
Federal student loans
Private student loans
Personal loans and financing
Payments for credit cards
Be patient. The best thing you can do to mend your credit is to pay on time, every time. Also, try to minimize the balance that you keep on credit cards and other debts. It is generally considered to be a good idea to focus on paying off those credit cards with a higher balance as it relates to the total credit limit. Lenders tend to frown upon over-utilized cards, which carry balances that are closer to their respective limits. It is also a good idea to target those cards with high interest rates first, because those rates can really add up and push your balance even higher. Resist the temptation to pay for a company that is marketed as a “credit repairer.” As the Federal Trade Commission puts it:
“Anything a credit repair company can do legally, you can do for yourself at little or no cost. Only time and a plan to repay debt will fix your credit. You can improve your credit by showing over time that you can pay your debts on time.”
Much more information can be found on the FTC site here. As proud partners in the management of your personal and business wealth, O’Donnell, Ficenec, Wills & Ferdig is also here for you with trusted insights, specific to your situation. You might be amazed at the outsized positive effects boosting this “little” number can have on your lifetime savings and day-to-day life. We encourage you to contact us with any questions. We are here to help!