Credit? What's that?

I was going to write a post about using credit cards effectively but decided to keep it even more basic than that for now.  I'll get into that on my next post.  Anyway, how many of us really know what goes into our credit scores?  I think it's safe to say that very few of us do.

Your credit, nowadays, says a lot about the way you pay your bills and handle your finances.  I have some underwriting (checking people's credit to see if they qualify for loans) experience and am usually confused by the way some people handle credit.  I want to ask them: "do you just not care at all about how much you pay in interest, or are you just stupid??" 

Here's why:

Your credit is a big factor in determining interest rates that you qualify for on loans, credit cards, auto financing, and mortgages.  A lower score means a higher interest rate which means YOU PAY MORE MONEY!  You may think this doesn't matter for short-term financing, but if you take something big - a mortgage, for example - it's going to cost you.  If you had a low credit score and took out a $200k mortgage on a 30 year term, you'd pay over $50k MORE than somebody with a high credit score.  I don't know about you but I would rather be proactive with my credit and save a lot of money on interest.

Credit is one of the most vital tools to putting you on the right track for financial success.  Most of the expensive things that we buy in our lives are purchased on credit.  Look at some of the expensive things you've purchased (or, if you haven't, what your parents have purchased.)  Your car, mortgage, big screen t.v., laptop for school, etc. are usually purchased on credit.  A good score will save you thousands of dollars over your lifetime.  Luckily for you, credit isn't very complicated once you lay it out.  Take a look for yourself.

Your credit is made up of a credit score and credit report.

Your Credit Score

A credit score is simply a number between 300 (low) and 850 (high) that tells lenders how risky it would be to lend to you.  There are five factors that determine your credit score:

1) Payment history (35%) - how well you pay on your credit accounts.  Paying on time is obviously the best thing to do!  If you can't pay on time, make sure you call your creditor, they can usually help you out.

2) Amounts owed (30%) or your credit utilization rate - this is the ratio of debt/available credit.  A lower credit utilization rate is always better!  For example, if I have a credit card with a $2,000 limit and I carry a balance of $1,500 on that card, my utilization rate is 75%.  This is not good and will have a negative impact on my score.  Carrying lower balances or no balances on credit cards is always better.  Your credit report will show that you have this credit available to you but are not using it. This is good for your score!  Also, make sure that you keep a credit card account open if you pay it off!  Closing a credit card will hurt your credit score in two different areas, so only close it if they are charging you an annual fee for benefits you are not using.

3) Length of credit history (15%) - refers to the amount of time you have had your credit accounts open.  Obviously, the longer an account has been open, the more history it has and the more it helps your credit (if payments are made on time.)  Also, see #3.  This part of your score is why you should keep credit cards open if they don't charge you any annual fees.

4) Types of credit used (10%) - this is pretty basic.  There are different types of credit accounts and loans such as credit cards, installment loans (i.e. your car loan), student loans, mortgage, etc.  Having different types of credit is good.  REMEMBER: store credit cards = crap.  They usually give you low limits and charge high interest.  Stay away!

5)  Inquiries (10%) - who is checking your credit?  A credit inquiry occurs when a lender checks your credit report.  This does have a small impact on your credit score and they add up; too many credit inquiries and BOOM, your credit score is down in the dumps.  Shopping around for credit is okay as long as you don't go overboard and have every lender in town check your credit!

That's your credit score.  Unfortunately, you can't get the actual score for free.  You can, however, buy a copy of your credit score from www.myfico.com.

Your Credit Report

A credit report is basically just an overall view of everything that goes into your score.  The report tells lenders your name, social security number, current and previous addresses, and sometimes even your employer.  It also shows who is giving you credit, how much credit they extend to you, how much you owe, your regular monthly payment and how many late payments you have made.  Collections and public records also show up on a credit report.

Having negative hits on your credit report could cost your score to drop which would affect the interest rates on any future credit you apply for.  Make sure you stay on top of credit!  It's one of the most important things to keep track of if you want to get ahead on your finances.  Luckily, each of the three credit reporting agencies (Equifax, Transunion, and Experian) will give you 1 free credit report per calendar year.  How generous!

To get an absolutely free copy of your credit report (not score), go to www.annualcreditreport.com.

Now you have all the information you should need to keep your credit score as high as possible.  Get to work.

As always, comments/questions/suggestions are appreciated!  teachmerich@gmail.com