Unfortunately, throughout life we are often defined by numbers. In high school we are defined by our GPA. When we are applying to college we are defined by our SAT scores. In life we are defined by our credit score. Whether you think it is fair or not, your credit score can and will affect your life decisions.
What is a credit score?
Your credit score is three digit number, similar to your GPA or SAT score, that banks, lenders, and other financial institutions use to determine your “creditworthiness” or how financially responsible you are. Your credit score can determine your interest rates on loans, such as your mortgage and car loans. It can also determine whether you get approved for certain credit cards and possibly leases. That number could even affect your job search. For example, any finance-related job will probably run your credit score. Trust me, if you have a bad credit score then chances are that financial company will think you’re bad with numbers and money. A 2010 Society of Human Resource Management survey found that 60% of companies checked parts or all of a candidate’s credit report.
How is your credit score calculated?
- Amount of balances owed (35%) – About one-third of your credit score is determined by the ratio of credit you have available and the amount of money you owe on each of your lines of credit. For example, lets say you have 3 credit cards (A, B, and C) and a mortgage. Your credit line for each credit card is $5,000 and the original amount you took out for your mortgage was $150,000. You currently have a balance of $2,000 on card A, $500 on card B, $0 on card C, and still owe $100,000 on your home. Your total credit available is $165,000, but you still owe a total of $102,500. Your ratio is 62%. That ratio may seem high, but it’s probably normal for many folks because of the mortgage. Let’s say though that you charge each card up to the limit and have a mortgage balance of $125,000. The ratio is getting much larger and your available credit is shrinking. Let’s hope you can pay those credit cards off!
- Payment history (35%) – Another third of your credit score is payment history. This means how many times have you paid your bills on time and in full. This is one of the most important aspects of your credit score. Obviously 99% of people can’t pay their mortgage off in full, but you can make the required minimal payments each month on time. Credit card bills should be paid in full each month. How late each payment is will also affect your score. If your payment is less than 30 days late then there is a good chance that it won’t ding your credit score. However, if you are 60 or even 90 days late with a payment, then your credit score will be dinged. Moral of the story, pay your bills each month. Almost all payments can be automated one way or another. It’s the best way not to miss a payment.
- Length of credit history (15%) – A small part of your credit score is the length of your credit history. It’s a good thing this is only about 15% of your score because most millennials are just opening lines of credit as they graduate and enter the real world of credit cards and auto loans. The longer your accounts have been opened, the better your score will be. Never close your oldest credit card. Just keep it open and just don’t use it if the card doesn’t offer the perks you want anymore (i.e., miles, points, cash back, etc.).
- Credit mix (10%) – There are different types of credit out there in the financial world – credit cards, mortgages, auto loans, etc. A variety of credit is a good thing for your credit score because it indicates that you’re responsible and can manage your finances, especially if you are paying them in full on time!
- New credit (10%) – New credit can affect your credit score as well. Opening new credit, especially a lot at once, can ding your credit score. It’s really not much, but if you’re credit score is on the lower scale, it could make or break you.
How do student loans affect my credit score?
Good question! The average college senior will graduate with over $30,000 in student loans this year and chances are you have student loan debt too. I know I do! Student loans can affect your credit score. Student loans are treated as installment payments by the three credit companies meaning that you agreed to pay the loan back plus interest in fixed monthly payments. Installment loans, like student loans and mortgages, don’t necessarily improve your credit score drastically, but if you miss payments or default on the loan, it can have major negative affects on your score. As noted above, about 35% of your credit score is how often you pay your bills on time. If you pay your student loan bills on time every month then this will help your credit score. If you can’t make your monthly payments because you just can’t afford them, then you need to contact your student loan lender and work with them to determine a new payment plan that works with your current budget.
I have a credit score of 650. What does that mean?
Credit scores are a number between 300 and 850. These numbers are known as a FICO number because they are published by the Fair Isaac Corporation. The three credit bureaus – Experian, TransUnion, and Equifax – all use these numbers. Let’s breakdown the range to see where you really fall.
- 300 to 629 – You have bad credit. You probably landed here because you’re young and have no history, you have consistently missed payments, or you claimed bankruptcy. You will face higher interest rates and fees and most likely will be denied many credit cards and possibly auto loans and a mortgage.
- 630 to 689 – You have fair credit. You score is considered average and you most likely have “bad” debt. Your “bad” debt is most likely credit card debt. You will most likely face higher interest rates and be denied many credit cards.
- 690 to 719 – You have good credit. Your interest rates are low and you will probably qualify for most credit cards, including those with the best reward programs.
- 720 to 850 – You have excellent credit. This means you get the best and lowest interest rates and will qualify for the best credit cards.
How do I get my credit score?
Getting your credit score is easy! Each year you are legally allowed to pull your credit report from each of the big credit bureaus – Experian, TransUnion, and Equifax – for FREE. Your credit report is not your credit score. Your credit report is in fact a report or summary of your credit history. Your credit report will contain information such as your name, social security, balances and available credit on credit cards, when you opened credit lines, and much more. Errors can and sometimes do happen on your credit reports so it is a good idea to check your reports yearly and correct any errors. To access your free yearly credit report then go over to Annual Credit Report to download it today.
Your credit score is not found on your credit report. Weird, I know. Your credit score is the 3-digit number assigned to you based on the information found on your credit report. Your credit score can vary too depending on the credit bureau you pull it from. Many credit card companies and banks may give you access to your credit score for free. My Barclays Arrival+ card and Mint both give me free access to my credit score. Barclays even allows me to graph my credit score over time because it can change monthly. In December 2014 my credit score was 750, but in January 2015 it is back up to 761. According to Mint.com, my credit score is 777. Barclays pulls my TransUnion credit score; whereas, Mint.com pulls my Equifax credit score.
If you don’t have access to your credit score through your bank or credit card companies then I highly recommend creditkarma.com. You’ve probably seen their ads on tv and they are truly free. I check in on my score quarterly. One of my favorite things about Credit Karma is that they will define your score for you. They will give you a “credit report card” broken down into the 5 factors that affect your credit score. As of today, my credit score according to Credit Karma is 767. In credit card utilization, payment history, total accounts, and derogatory marks, I scored an “A.” In age of credit history I scored a “D” because my average account age is 3 years and 4 months. This is because I’m young. As I get older it will get better. I also scored a “C” in credit inquiries because I recently opened a couple of credit cards (get on that 50,000 mile bonus Barclays US Airway card before it’s gone!!) so that affected my score slightly.
Another feature about Credit Karma I like is the ability to compare my score to others in my state or across the United States. Currently my score is almost 92% better than all of the Credit Karma members. My score is better than over 95% of people aged 26-30 in the state of Maine.
How can I improve my credit score?
Credit scores vary month-to-month and also credit bureau-to-credit bureau. Here are a few tips to improve your score over time:
- Make payments in full and on time.
- Automate your monthly payments and you’ll never miss a payment!
- If you have any bills in collection then you need to take care of it NOW. Collections will affect your credit score until you take care of it. So do it now!
- Never close your oldest credit account.
- If you have debt, especially credit card debt, make a repayment plan and pay more than the minimum balance to eliminate the balances as quickly as possible.
- Keep your balances low. Some financial planners suggest using less than 30% of your available credit on each credit.
- Check your credit report yearly for any errors. If you find errors then you should correct them.