What's the Deal With Credit?

What’s the Deal With Credit?

When you think “credit” what comes to mind? The guys from freecreditreport.com jamming out in their mom’s basement?  The cartoon old lady from Credit Karma?  Commercials for credit are almost as ubiquitous as the Geico gecko and Flo from Progressive hawking car insurance policies.  Why so prevalent? Because credit is that important.

Credit not only determines the financing rate you get on the biggest purchases of your life - like your home - credit is also used as the definitive measure of financial dependability to determine your insurance rates, rental opportunities, and in some cases, employment prospects.

But what exactly is your credit score and what does that score mean for your financial future? To put it simply, your credit is a measure of how well you borrow money.  It has nothing to do with your income and everything to do with how well you pay your bills and debts.

The credit score is calculated from information reported to the major credit bureaus, with each piece of your financial history weighing differently on the final calculation.

The Credit Breakdown

35% Payment History.  By far the most important part of your credit score is a history of on-time bill payments - credit cards, loans, even utility payments factor in.  Just a single missed or late payment can result in a significant score drop.

30% Credit Utilization.  You never want to use too much of your available credit at any one time.  Even if your credit card limit is $1,000, experts recommend keeping your utilization well below 30% - in this case, $300.

15% Length of Credit History.  While you can take full responsibility for on-time bill payments and proper credit utilization, there’s not much you can do to improve your length of credit history - other than wait it out.  What you can do is make sure to keep older credit accounts open and in good standing.  As long as there’s no pricey annual fee, it’s best practice to keep your oldest credit card open, as closing it could wipe out valuable history.

10% New Credit.  It doesn’t reflect well on your credit when you open up a slew of new credit lines in quick succession.   Nothing says, “I’m desperate to borrow more money” quite like an onslaught of new credit and loan applications.  So be wary before automatically saying yes to that retail card that’ll give you 15% off your entire purchase.  It’s fine to open new accounts, just be mindful of the timing.  You don’t want an impulse decision at checkout to cause your credit to suffer.

10% Types of Credit Used.  Mix it up!  Diversify your credit with a mix of revolving (ex. credit cards), installment (ex. mortgage and student loans), and open credit (ex. utilities and cellphone).

Once all of the factors are weighed, you’ll be left with a number between 350 and 850.

750-850 - Excellent.

660-749 - Good.

620-659 - Fair.

350-619 - Poor.

If you have no history of borrowing money however, your score will probably be a big fat zero, making it difficult for you to be approved for any kind of financing.

Why does all of this matter anyway? 

A high credit score signifies a good history of borrowing, and to lenders that translates to less risk.  That kind of dependability means access to the lowest interest rates and the best financing promotions, which can save you thousands over the life of a long-term loan like a mortgage.

Good credit is the ultimate savings tool when it comes to your biggest financial decisions.  Set yourself up for a good deal by building your credit history now, making regular payments on all of your loans, and keeping your score in check for the future.