Understanding and raising your credit score
People are always talking about the importance of a good credit score, but what exactly is a credit score? In short, your credit score “is a statistical method to determine the likelihood of an individual paying back the money he or she has borrowed.” In other words, it’s a grade given to your credit worthiness.
Your credit score determines the loans you can be approved for and the interest rate you pay on them. For example, if you have a score of 780 you will likely get the best mortgage rate possible, let’s say 4%. If you have a lower credit score, like 620 you might end up paying 4.75% Over time, the difference in rate could end up costing you over $25K by the time you payoff your mortgage.
But it goes beyond that. Some landlords use credit scores to determine who they’re going to rent to. If you have a low score you might be considered a risk so you may be asked to put down a larger security deposit. Your credit score can affect almost anything from your car insurance premiums to the cell phone plan you can get.
To get the lowest rates and most benefits, you must work to reach and maintain an excellent credit score. I’ve included an easy breakdown of credit scores below:
Bad credit – 600 or lower
Poor credit – 600 – 649
Fair or average credit – 650 – 699
Good credit – 700 – 749
Excellent credit – 750 or higher
If you have a bad credit score do not despair. Your score is not permanent and can be raised over time. In general, credit scores are based on five factors.
Generally considered the most important factor when calculating your credit score is your payment history. It accounts for roughly 35% of your rating, which (as you’ll soon learn) is the most weighted factor in determining your score. In very basic terms, this is an evaluation of whether you make your monthly payments on time and in full. The best thing you can do to raise your credit worthiness is to consistently make your payments on time, if not early.
Naturally, the next question is what to do if you can’t avoid being late. If you’re a few days late or a week likely it won’t be a huge deal to your creditor, but if you get all the way to 90 days and end up delinquent it’s going to have a serious effect on your credit score. If your payment gets marked as delinquent it can stay on your credit score for up to seven years.
Some companies won’t report a late payment until sixty days have gone by, but most will mark your credit score after thirty days. That derogatory mark on your credit could drop your score by up to 110 points. If you’re shopping for a house or car that will severely affect the interest rate you’ll be offered or even your ability to qualify.
If you’re behind on a payment and don’t immediately have the ability to make a payment, we recommend you contact your creditor to see if they can offer you any type of leniency.
The next biggest factor is the amount you owe and your utilization rate. Your utilization rate is the amount of credit you use, compared with your limit and makes up approximately 30% of your credit score. For example, if you have a $5,000 limit on your card and you use $4,500, you have a utilization rate of 90%.
This is the single biggest issue we personally see at Olive Branch. Many consumers are 60-90% utilized, putting them in a difficult position when they try to refinance the debt.
Credit companies want ensure that you’re going to be able to repay the new debt they extend to you, in addition to your current obligations. In general, a good utilization rate is about 30%. That means only spending up to $1,500 a month on a card with a $5,000 limit. If you can keep your utilization down to around 10% you’ll see a positive effect on your credit score.
You can also lower your utilization by increasing the limit on your card. If you do that, ensure you don’t increase your spending with the increased limit!
Creditors and financial institutions want to see you have a long history of paying your bills. Think of it like you’re hiring a doctor, are you more likely to hire the one with a year of experience or ten years? The longer you’ve had accounts open with positive utilization and payment history, the better your score will look. Your credit card history makes up roughly 15% of your score.
Creditors want to see what kinds of credit you have. For example, a car loan, home equity loan, credit cards. They want to see that you’re able to maintain and pay different sorts of credit. Your credit mix makes up 10% of your score.
Each time you apply for a loan or a new credit card those hard inquiries show on your credit report. Most creditors view a high volume of credit inquires as a risk; it also could indicate that you already took out a new loan that’s not yet reporting. New credit inquiries make up 10% of your score. Don’t be afraid to stop around for a loan, but try to use lenders who use a soft check so you can see your options before agreeing to a hard check.
In summary, the most powerful ways you can increase your credit score are by paying your accounts on time and in full, and utilizing less than 30% of your available limit. If you have no credit or are credit challenged, consider getting a secured credit card to increase your score. A secured credit card is connected to a bank account with a set amount of money that acts as collateral in case you can’t pay your bill.
There are number of ways to check your credit score. Here are a couple of free ones:
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