Why Your Credit Score Matters and How to Fix It
In this last ten years, much has changed when it comes to credit and credit scores. I was working a part-time job in college in 2008 for a credit card customer service call center when the Fair Credit Reporting Act was brand new. Needless to say, there were many trainings and lots of phone calls and emails about the changes being made. I was lucky as such a young adult to be able to witness how credit cards work and how scores can change and how to best manage multiple credit accounts. I can safely say that job was not for me nor is any other phone based customer service job, but it paid well for a college student; both monetarily and with invaluable knowledge.
If you are new to my blog you may not know that my household growing up “debt” was a four-letter word and we often made sacrifices to get by. My parents paid off their mortgage in about ten years and when I went to college my dad told me I would be taken out of the will if I took out any student loans. I think he was kidding, after all, I’m an only child. I did end up taking one loan my senior year and to my knowledge they have not made any changes to their will.
First let me explain where your credit score comes from…
Credit reporting agencies
There are multiple credit reporting agencies, you may hear about Experian, Equifax, Trans Union or FICO when talking about the corresponding scores. These scores are pretty much always different and are used for different things and by different banks. They are supposed to reflect the likelihood that you will repay your debt. Credit scores usually range from the 300s or 500s to 800s on most scales with the average score falling in the 600s. Each agency has a different score range so be sure to check your score with the corresponding scale for an accurate depiction.
This is probably the most obvious of the things used to determine credit score. To improve in this area, continue to ensure all payments are made for at least the minimum payment amount prior to the scheduled due date. If you are having issues making your payments on time you may need to make a budget to make sure you have enough money to keep up with your monthly expenses. Remember, if you are trying to get out of debt you will need to be spending less than you earn going forward in order to alleviate past debt from living beyond your means. As long as you are following a budget and living within your means, there is no reason not to have a perfect payment history. Begin this immediately and set reminders or automatic payments to keep up, this takes time to build up your credit.
Oldest credit line
This was probably my biggest take away from working in credit customer service. I was 21 years old and preparing to enter the real world in about a year and I only had about a year and a half of credit history. I am 27 now and still have my very first credit card account open even though I don’t really use it because there are no rewards on that credit card. If I close this card, My length of credit history would be shortened by at least 2 years and I only have about 8 years so that’s 25% of my credit history! Pay off your oldest card but DO NOT close it. The only exception I would make is if there is a large annual fee that does not have a nice rewards program.
The more credit you are using, the more likely it is that you will at some point have to pick and choose who you pay back. Banks see this as a risk to lend to you. If you have high revolving balances before opening a new line of credit then how will you pay off even more debt? I recently learned that your accounts have a certain day that they report to the credit bureaus. So if you have a credit card with a $1000 limit and you have a $900 balance when your bill comes but you wait a week to pay it and they report out during that week, your utilization is 90% even if it was previously and shortly following, paid in full. Be mindful of this and either have credit cards that sit around basically collecting dust or make multiple smaller payments throughout the month. Or both!
The higher the number the better. This shows that you have credit available to you but that you don’t need it. If you need credit to get by, you are likely to not be able to afford that bill when it comes due. Banks want their money back and they don’t want to risk never seeing it again or pursuing legal action to get it. Keep this in mind as you make credit decisions that you may be on the fence about. My natural instinct is to ask for my credit limits to be lowered, and I have done so on multiple occasions. Ultimately, that can hurt more than it helps unless you are having trouble resisting the urge to max out all of the plastic in your wallet.
This is currently the category that is hurting my credit the most. In the last 12 months I have leased a car (yeah yeah, I know), put in multiple offers on homes, and opened a new credit card. Per my credit card’s credit monitoring service I have 7 recent (2ish years) inquiries. I would recommend not doing an inquiry more than once every 6-12 months. Do as I say, not as I do, right? Buying a house totally killed me here but luckily I’m pretty strong in the other categories to carry me until some of these inquiries fall off. This is a pretty easy category to control outside of making major purchases so be careful when you buy cars and houses. Always always always ask if a bank or other institution is running your credit before you give your information. Obviously they will need to do it when you are making a purchase or applying for a new card but sometimes the employees at XYZ department store are not very forthcoming with some of the details as to how you can get an “extra 5, 10 or 15% off.”
This is along the same lines as the inquiries, as an inquiry is usually required to see if you qualify for the account or what amount you qualify for. Too many accounts opened too quickly will hurt you. I am currently dying to open a Target Red card but I just opened a rewards card that is a part of our master plan to be frugal and debt free. Plus I know I will be buying a car when my lease is up in about a year.
Which brings me to my next point…
Why does your credit score matter?
Most people know that a credit score will affect whether or not you are approved for a credit card/ car loan/ mortgage or the amounts that you will be approved to borrow. While this is certainly true, it is not the only or even the most important reason your actual score matters. Your credit score should not be looked at as Pass/Fail like music or art classes in high school. In most cases, that’s how it is treated and your debt to income is important pertaining to the amount you can afford to repay. If only it were that simple. While preparing to buy a house, I was doing some massive credit repairing even though we were already approved for tens of thousands more than we could ever afford. But, why?
If you have a good credit score, you are rewarded with lower interest rates which lowers your total payment and overall cost of the loan overtime. I made some mistakes (mostly human error) and took a few hits to my credit score, small mistakes can drop a score 50+ points and take years to recover and get back to the previous score. When buying a house (or applying for any kind of debt) the banks go by the lowest credit score rather than averaging between two spouses. In our house, it’s my credit score holding us back. There are different tiers of credit scores and the interest rates change based on the market but we knew that we were right on the line of being able to get a better interest rate. (Luckily, they dropped right before we locked in and got our mortgage at 3.75%)
Even a slight change in interest, from 3.75% to 4% would change our monthly payment by about $30 per month. That adds up to more than $10,000 over the course of the loan. I don’t even want to know how much money we will throw away over the next 30 years because my credit score prevented us from getting the lowest interest rates available. So when it comes to the actual score itself, don’t settle for “good” or “average” just because you can get approved for the amount that you want, keep pushing it higher so you can save hundreds or even thousands in interest on your next major purchase.
These mortgage payment calculators show the difference in 0.5% over the course of the loan, $56 per month and $20,000 extra in interest. I know I could do a lot with $20,000 in the next 30 years. Be sure to check on the interest rates if you are considering buying a house or see if refinancing may be a good option. Taking a loan for a shorter term can result in an even lower interest rate.
How you can fix your credit score
Now that you know what goes into your score, you can assess your situation to begin making the changes that will help you the most. For some, this may mean taking a small loan and paying it off immediately. For others, you may just want to reduce the balances on existing debt. Unfortunately, there is no “one size fits all” answer for how you can fix your credit score. Start with making at least the minimum payments on all debts owed on time every time. Once you are comfortable in this step, you may want to pay extra until you are no longer carrying a balance and then possibly open new lines of credit. Be careful not to open too many new accounts too fast and don’t open more than you can handle.
Have you ever made significant improvements to your credit score? How did you do it?