What is Credit?
Credit is a critical element of well-managed finances. Building good credit is bound to affect you in almost all your major financial decisions and purchases. Credit is more than just a plastic card you use to buy things. It is your financial trustworthiness. Good credit means that your history of payments, employment, and salary make you a good candidate for a loan and creditors. Those who lend money or services will be more willing to work with you.
Factors that determine your credit score:
- Payment history (about 35% of the score) – Making payments consistently on time indicates responsibility.
- Amounts owed on credit accounts (about 30% of the score) – A large number of accounts with balances may indicate that you are over-extended.
- The length of credit history (about 15% of the score) – A longer credit history generally increases the score.
- New credit (about 10% of the score) – An established credit history, without too many new accounts. Opening several accounts in a short period can indicate greater risk.
- Types of credit (about 10% of the score) – a mix of different types of credit. However, this factor is usually not important if there is other sufficient information upon which to base your score.
The above factors are important for the credit bureaus to determine the type of financial personality you have. Organizations such as banks, insurance companies, and even you employers can use this information to determine how financially responsible you are.
How to improve your credit score:
- Avoid using credit cards if you’re already in financial trouble. Finance charges and other fees will add to your debt burden. However, using your credit card in a time of financial difficulty is better than taking out a home equity loan, where your home is put on the line.
- Don’t get hooked on minimum payments. Some credit card issuers have set their minimum payments as low as 2% of the balance. Others may set it to 4%. If you pay only the minimum, it will take a long time to pay off your debt. For example, if you owe $5,000.00 on an account with 18% APR, making 2% payments will take over 44 years to pay off. Also, you will have paid $12,431.00 in interest.
- Make your credit card payments on time. Avoid late payment charges and penalty fees if you can. Bad problems get worse fast when you have late fees and higher rates to pay during financial difficulty. It’s worth calling to ask for a fee to be waived if you were accidentally late, or have a good excuse.
- Don’t max out your cards. It’s easy to get hit with over-limit fees. Also, a credit card account close to its limit will cause a drop in your credit score. Be aware of whether or not your account allows you to spend over your limit, as this is optional. Maxing out your account, or even getting close to your limit will increase your credit usage ratio, which can illustrate a dependence on credit that lenders don’t like to see.
Why shouldn’t you obsess over a high credit score?
A credit score is a numerical representation of a consumer’s capacity to pay back a loan. FICO scores range from 300 -850. FICO score category ranges:
– Excellent credit: 781-850
– Good credit: 661-780
– Fair credit: 601-660
– Poor credit: 501-600
– Bad credit: below 500
What matters most is the fact that you manage your credit scores above the fair credit score range. Credit scores are calculated by multiple agencies, and one may vary from another. Your credit score can vary within the same day as well. Therefore, obsessing over perfecting your score might be a waste of your time. Your efforts should be more focused on maintaining your score within a healthy range.
Biggest credit mistake
Ignoring your Credit Score is one of the biggest mistakes made by consumers. There may be mistakes in your credit report that you may want to attend sooner than later to avoid any major impact in the future. A regular watch on your credit score allows you to identify any potential problems in the way you use credit (such as late payments or high balances), correct anything that isn’t accurate, and even spot signs of identity theft, such as accounts or applications you don’t recognize. You can request your free credit report from AnnualCreditReport.com, and check it for any inaccurate information.
To speak to a credit counselor today about budgeting and managing your finances, call 800-769-3571.