Credit & Credit Score

Love it or hate it we can’t get away from credit. From your first vehicle purchase, to your first home loan, it is often misunderstood and for most of us who are not aware or educated on the subject, it will prove to be costly.

Many of us have horror stories of ruining our credit by not paying credit cards on time, or any other loans we have pending; however, credit doesn’t have to be a scary subject and will prove to be one of the most important aspects of your your financial future.

What is Credit & Credit Score?

Credit is the ability to borrow money/funds from a lender with the understanding that you will pay the money back in full. These merchants, lenders, banks are known collectively as “creditors”, and they are the ones that determine your “creditworthy” – that is if you are financially sound enough to justify future loans or extension of credit.

A simple way to think about credit score is to think about your reputation. Think of that uncle or auntie, or any other relative that once asked you for money and never paid you back. Did you ever lend them money again? Probably not, and did you tell your relatives about them so they wouldn’t fall victim to them as well? You probably did, and rightfully so as they would probably not pay them back as well. This is similar to how a credit score works in the perspective of lenders and creditors.

This “credit score” will determine whether you are someone they can trust to lend money to, or if you are too risky and they will rather not. At times if you are too risky of a borrower, they might still let you borrow; however, this will cost you dearly as they will charge you higher interest compared to someone who has a higher credit score.

Do I have a good credit score?

Here’s a table representing the FICO credit score ranges along with the percentage of Americans with these scores:

ScoreDescription% of people
300-579Poor16%
580-669Fair17%
670-739Good21%
740-799Very Good25%
800-850Exceptional21%

Why should I care about these credits scores?

Let me ask you a series of questions and if the answer to any of them is “Yes”, then these scores will absolutely have an impact in your wallet in the near future.

  • Are you planning on buying a new car?
  • Are you planning on buying a house?
  • Are you planning on buying anything else that you might not have enough funds to buy it in cash?

Let’s assume you answered yes for buying a new house and you currently have a credit score of 660 (Fair). The house you are attempting to buy is $300k, you’ve decided to go on a 30-year fixed mortgage and live in Texas (Yeehaw!)

Below is an image of the interest rate (APR) that you will qualify for (3.057%), and the total amount of interest that you will be paying at the end of the loan.

Loan Saving Calculator – Source

As you can see, you will pay $158,659 compared to someone who had a 760 score that paid $123,257 on the same $300k loan. You could potentially have saved $35,402! Enough to buy you that new car you wanted!

Again, as your credit score improves over the years, it will provide with better lending options such as lower interest on loans and will allow you to be “creditworthy” by most creditors. (Note: a higher credit score doesn’t guarantee the lowest interest rate as there are other factors such as income level, current debt, etc.. that will be taken into consideration).

Wow! It all makes sense now! How do I improve my credit score?

Now that you see that credit scores have a real impact in the real world, let’s see what makes up your credit score, and what kind of information will be in your credit report when your bank or any other “creditors” pull your credit report. A Credit Report shows your bill payment history, current debt, and other financial information, this is what your lenders will use to calculate your credit score.

….

Let’s translate this table into recommendations & action items:
  • Make your payments on time! (Follow this article to ensure you don’t miss your payments).
  • Maintain a good Debt-to-Credit Ratio – Less than 30% (for example if your credit card limit is $10,000 don’t spend more than $3,000).
  • If you have a credit line (e.g. Credit card), ensure that you don’t constantly open and close those accounts as they will impact your credit score.
  • Don’t just rely on having 1 credit card, ensure that you have other credit sources (Car loan, Mortage, etc.) Note: I’m not suggesting to further get in debt, I’m just suggesting that you should have more credit lines.

How do I check my credit report?

You are entitled to a free credit report once a year from each of the three major consumer reporting companies:

  • Equifax
  • Experian
  • Transunion

You may visit www.annualcreditreport.com to request your free report (Note: annualcreditreport.com is the only legitimate website to pull your official credit report without cost, you will find hundreds online so be careful!).

Below is an image of how the site should look like:

For more information you may visit the Consumer Financial Protection Bureau site which contains more information.

As a reminder your Credit Report will show your bill payment history, current debt, and other financial information, which is used by your lenders to calculate your credit score. You will NOT see your credit score here.

How do I check my credit score?

If you have a credit card, you can easily login to your web portal and review your online account which should include a section for your credit score information. For example if you’re are Capital One customer, you may utilize their CreditWise credit monitoring to pull your credit score.

Conclusion

As you can see, building a good credit score is both feasible and a must for those buying their first piece of property, obtaining a business loan, buying a vehicle, etc. as it will have a direct financial impact on our future choices.

If you’ve had difficulty in the past with your credit score, don’t worry! There’s always lessons learned and you still have time to improve your score and ensure that you set yourself to a debt-free path. This article should help in setting up an automatic payment system that will ensure you never miss a payment again!

Again, there’s still time to amend the mistakes of our past! Good luck!

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