Your Credit Score and You

Do you know your score?

With the birth of online credit score tracking on sites like CreditKarma, CreditSesame, and Mint, everyone wants to find out: what’s my number? However, many of us have no idea what that number means. In this post, I’ll cover the following topics:

  • How Your Credit Score Works
  • Why You Should Care, and How Much You Should Care
  • How to Improve Your Score
  • How to Check Your Score

Credit scores are a great way to keep yourself in good standing with various lending institutions. They also help you protect yourself from credit fraud and identity theft. Sometimes even your landlord will care about your credit score when deciding whether or not to let you rent an apartment, using it as a heuristic for trustworthiness. Clearly, it’s important, and is an essential part of learning to handle your finances as an adult.

How It Works

There are three credit reporting bureaus: Equifax, Experian, and TransUnion. They will produce a report on your credit every year, which you can retrieve for free and read at annualcreditreport.com . If you pull your reports, you’ll notice that they don’t contain a credit score (though you can pay to get it, which you shouldn’t do because it’s available for free elsewhere). Your credit score is calculated from the information on those reports. The most common among these scores is the FICO (Fair Isaac Corporation) score. There are other models out there for calculating your score, but I won’t get into the details of those for now. When starting out, your FICO score should be a good enough point of reference. The score runs from 300 (worst) to 850 (best).

The components of a FICO score
The components of a FICO score

The factors that make up your score are:

  • Payment History: Do you pay your debts on time? If you have a credit card, do you pay your statement off in full every month? Do you make your loan payments every month as required by your contract? This is the largest and most important part of your score. Be sure that when you take out a loan or swipe your credit card that you can pay what you owe.
  • Amounts Owed: Banks don’t want to loan you money if you already owe somebody else a big chunk of your income. If you already owe $10,000 on a credit card, why would a bank want to issue you another one? If you’re still paying off that $5,000 TV, will you really have the funds to pay for this car?
  • Length of Credit History: This one is a pain in the butt for most young professionals, but one of the best ways to prove your credit worthiness is to show good credit history over a long period of time (several years, the longer the better).
  • Credit Inquiries: Every time you apply for a new line of credit (a loan, a credit card, an overdraft line of credit on a checking account, and so on), you’ll probably get a credit inquiry. These inquiries indicate that a lender checked up on your credit score.
  • Types of Credit: It can be encouraging for a lender to see you successfully using different credit types (for example, you’re consistently paying off your credit cards and also handling a longer-term loan like a car loan).

Why (and How Much) Should I Care?

There are two main reasons to be concerned with your credit score:

  1. Elligibility and favorable terms for lines of credit (loans, mortgages, credit cards)
  2. Defending yourself against fraud

#1 is the chief reason why most of us care about our score. We want the fancy new rewards credit cards, or the low interest rate on our car loan or mortgage. These are definitely good reasons to care, as they can save you huge amounts of money over the course of your life! On a 36-month $15,000 car loan, the difference between a 10% and a 5% rate is over a thousand dollars in interest saved over the life of the loan. Keep in mind, too, that even if you aren’t planning on getting a loan anytime soon, your credit score is something that is built over many years, so even if you don’t think you’ll be buying a house for a decade, it will help you to get started now. Short-term considerations like not having to put down a deposit with your utility company when you move to a new apartment (because your good score means they can trust you) can also make it worth your while.

#2: Defending yourself against fraud is another helpful element of keeping a mindful eye on your credit score. Unfortunately, we live in a world where personal data is frequently exploited. You don’t want someone else stealing your social security number and maxing out a hundred cards under your name. Checking your reports once or twice a year for fraudulent activity is a good way to make sure everything is in order.

Now that you know why you should care, I’m also going to tell you why you shouldn’t care too much. A couple points of variation aren’t going to kill you. The difference between a 710 and a 720 is pretty negligible, and shouldn’t keep you from, for example,  applying for a nice airline miles card to save yourself some money on travel just because you’re scared of the inquiry. The only time where minor fluctuations like this really matter is when you’re getting a large loan like a mortgage. With a huge mortgage loan, every 0.1% off the interest rate will save you thousands, so it’s worth being extra careful with your score to try to get an even slightly lower rate.

How to Raise Your Score

  1. Wait Around: As frustrating as it is, one of the best ways to improve your score is to be patient. Scores will go up over time as long as you’re being responsible. If you’re new to credit, you’ll just have to keep up the good work and rest assured that it will eventually be recognized. If you were irresponsible in the past, it’s as the saying goes: time heals all wounds.
  2. Be a Man (or Woman) of Your Word: If the contract says to pay your lender $300 per month for 36 months, you’d better do it on time every time. Pissing off your lender is a good way to get a huge ding in your score. In the case of credit cards, pay off your balance in full every month (always pay the full amount that your statement says you owe).
  3. Don’t Take Out Too Much Credit At Once: Don’t apply for fifteen credit cards in one month. Don’t take out a $30,000 car loan when you could get by just fine with a reliable $10,000 car. All things in moderation.

How to Check Your Score

Checking your score is free, and here are a few ways you can do it:

  1. Sign up for CreditKarma.com to get your TransUnion and Equifax scores. They also have a nice interface for letting you view the contents of your credit reports (so you can see exactly what goes into calculating your score).
  2. Sign up for Mint.com and get not only an awesome budgeting and financial tracking tool, but also your Equifax score.
  3. Sign up for CreditSesame.com and get your Experian score.
  4. Sign up for a credit card that includes your credit score on your monthly statement. See this article for a good list.

You now know everything you need to know about your credit score! Happy borrowing!

Do you know your credit score? Have you found any good strategies to keep your credit in check?

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