Personal Finance 101: Master Your Credit Score
By Brittany Mollica
New year, new you! If you’re starting 2021 with a goal of bettering your finances, it may be time to improve your credit score. Let’s start with the basics – understanding your credit report and your credit score.
What is a credit report?
A credit report is a regularly updated document that details your credit history. There are three main credit bureaus that generate credit reports (Equifax, Experian, TransUnion), but the information on each report should be very similar. Your credit score is based on the information in these credit reports.
What is a credit score?
A credit score is a numerical value used to assess the risk you pose as a borrower – essentially helping lenders predict the likelihood of you defaulting. A higher score means you’re less of a risk and will usually get you access to better interest rates; a lower score means you’re a higher-risk borrower. Because a high score can get you a lower interest rate, especially on debt such as car loans and mortgages, it can pay off significantly long-term! There are different formulas used to calculate your credit score, so each credit bureau will assign you a slightly different score. The two most common models are FICO® and VantageScore®, and these generate scores that range from 300-850.
Got it. How is my credit score calculated?
Your credit score will fluctuate depending on which model is used to calculate it. The FICO® score is the most commonly used model and is computed by looking at five factors:
1. Payment history
This category accounts for 35% of your FICO® score and looks at whether you consistently make debt payments on time. One late payment can significantly impact your score.
2. Credit utilization
This category accounts for 30% of your FICO® score and considers your credit utilization ratio: the ratio of your outstanding revolving debt divided by the total credit available to you (essentially it’s your total credit card balance divided by your total credit card limit). The lower the better!
3. Credit history length
This category accounts for 15% of your FICO® score. It reviews the age of your oldest credit account, the age of your newest credit account, and the average age of your accounts overall. Having a longer history of responsible credit usage is helpful. This is why we often recommend teenagers or young adults obtain a credit card early on.
4. Credit mix
This category accounts for 10% of your FICO® score and looks at the diversity of your types of credit. Having a credit history that includes more than just credit card debt (e.g. car loans, student loans, mortgage, etc.) will be beneficial.
5. New credit
This category accounts for 10% of your FICO® score. This looks at the number of accounts you’ve recently opened and the number of hard inquiries that lenders have recently made (a hard inquiry is when a creditor requests your history because you’ve applied for a loan). You don’t want to have too many new accounts or hard inquiries.
The main takeaway: payment history and credit utilization are the most important factors. And while other credit score calculation models will have slightly different formulas, they should all result in fairly similar scores.
OK. How do I check my credit score?
We feel that it’s more important to check your credit report than your credit score, because the score is calculated from information found in the report. You can check your credit report for free once a year through each of the three credit reporting companies (visit https://www.annualcreditreport.com to easily access all three). Requesting your annual credit report won’t affect your credit score because it’s classified as a soft inquiry rather than a hard inquiry. You can request all three credit reports at one time, or you can request a different report every four months to spread them out over the course of the year.
If you’d like to get an idea of what your credit score is, you can find that information a few different ways. Some financial institutions (bank, credit card company, etc.) might provide you with a credit score (such as Capital One’s CreditWise service), or you can look at Equifax, Experian or TransUnion’s website for their credit score services. You may also opt to pay a small fee to receive your score through the link mentioned earlier (https://www.annualcreditreport.com).
Ah, my score is not great! How can I improve my credit score?
There are many good financial habits that you can implement to improve your credit score:
Make sure your debt payments are on time every time. Negative information on credit reports (such as late payments or defaults) can take up to seven years to go away, so you may want to set up automatic payments from your checking account to avoid the chance of a forgotten bill. Note: if you do this, make sure your checking account always has enough cash to fund your debt payments.
Never charge more to a credit card than you can immediately pay off. This will keep your credit card utilization ratio low and will help you build a strong history of paying off debt.
If you already have a significant amount of credit card debt, prioritize paying this down. Having a lower credit card balance will improve your credit utilization ratio, which has a sizable effect on your credit score.
Regularly check your credit report. By knowing what’s on your report, you will be able to see areas for improvement and you will also be able to proactively correct any errors.
If you only have one credit card, consider getting an additional credit card to increase the total credit available to you. Similarly, if you have a credit card that you don’t use, consider keeping the account open so as not to reduce the amount of credit available to you.
When needed, seek help from a professional. While we are not credit counselors, there are specialists who can help you manage your debt and improve your credit score.
Building smart financial habits can improve your credit score and set you up for financial success. If you’d like to speak with an advisor about any of these topics and their role in your financial plan, please reach out to us today!
Sources:
https://www.experian.com/blogs/ask-experian/credit-education/score-basics/my-credit-score/
https://www.annualcreditreport.com/generalQuestions.action
https://www.transunion.com/credit-score
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