Tag: credit score

  • No Need to Obsess Over Credit Score

    No Need to Obsess Over Credit Score

    Your credit score is very important.

    And, you need to stop obsessing over it.

    Here’s why both those statements are true.

    Your credit history will touch almost every important financial transaction you enter into today. I don’t just mean credit cards and loans.

    If you apply for a job, need insurance, or want to rent an apartment, those companies are going to review your credit report and credit score.

    So, even if you don’t intend to take out loans, your credit history and credit score are still important.

    But, obsessing over your credit score is counter productive.

    Has obsessing over any number ever served you well, anyways?

    GPA…

    Weight…

    Social Media Followers…

    Yes, these things may be important to you. But, obsessing over the number itself is not how they improve. The habits behind the number are more important.

    If you want to improve your GPA, you need to study more.

    To lose weight, you need to practice healthy living.

    For more social media followers, you need to create better content.

    The same logic applies to credit scores.

    If you want a good credit score, the best thing to do is to practice strong personal finance habits that we routinely discuss in the blog.

    Obsessing over your credit score number is a waste of mental energy.

    With this backdrop in mind, we can discuss credit scores.

    What is a credit score?

    As we learned in our post on using credit the right way, credit refers to an agreement to borrow money with the obligation to repay that money later, usually with interest. 

    Credit also refers to a person’s trustworthiness or history of repayment.

    We then learned that a credit report is a document that tracks that history of repayment, as well as the current status of any loans you’ve taken out.

    Your credit report will typically include:

    • Personal information (name, social security number, current and former addresses)
    • Credit accounts (current and historical accounts, including credit cards and any other loans)
    • Collection items (missed payments, loans sent to collections)
    • Public records (liens, foreclosures, bankruptcies)
    • Inquiries (when you apply for a new loan)

    Now, we’ll talk about credit scores.

    A credit score is a three-digit number calculated based on your credit history that represents your present day creditworthiness. 

    Your credit score captures a moment in time. That means it will change over time, sometimes quickly and dramatically.

    We each have multiple credit scores depending on the scoring service. While there are many others, the two main scoring services are FICO and VantageScore.

    Keep in mind that your score may vary depending on the type of loan you are applying for. For example, an auto lender looks at different factors than a mortgage lender.

    For that reason, FICO alone has more than 50 different versions of your score that it may send to lenders.

    What is a good credit score?

    FICO and VantageScore each assign a score ranging between 300-850.

    For both services, if you’re around 800, you’re doing very well. If you drop below 650, you’ve got some work to do.

    Businessman trying to improve credit score with the lessons learned on Think and Talk Money.

    Before we look at the factors that go into your credit score, I can’t emphasize this next point enough:

    Don’t obsess over your credit score.

    You certainly want to pay attention to dramatic changes in your score so you can understand where you need to make adjustments. That said, you should not be concerned with slight movement in either direction.

    For example, FICO considers a score between 800 and 850 as “Exceptional.” Once you’re in that range, it makes no difference whether your score is 804 or 837. You may notice slight variation from month to month. That’s normal and perfectly fine.

    Instead of worrying about fluctuations in your score, spend your time and energy on more important financial wellness strategies, like writing down your Tiara Goals.

    What factors go into your credit score?

    Regardless of the scoring service, your credit score generally consists of these factors:

    • Payment history
    • Current unpaid debt
    • The types of loan accounts
    • Length of credit history
    • New credit inquiries
    • Amount of available credit being used
    • Collections, foreclosures or bankruptcies

    Of course, not each factor counts equally. For example, FICO weighs each factor like this:

    • Payment history: 35%
    • Amounts owed (credit utilization rate): 30%
    • Length of credit history: 15%
    • Credit mix: 10%
    • New credit: 10%

    VantageScore does not assign percentages to each factor, but does define the importance of each factor like this:

    • Payment history: Extremely influential
    • Total credit usage: Highly influential
    • Credit mix and experience: Highly influential
    • New accounts opened: Moderately influential
    • Balance and available credit: Less influential

    In comparing the two main scoring methods, we can see that both methods generally look at the same factors. They both also place the highest emphasis on payment history and place less emphasis on new accounts opened.

    Here’s all you need to know about each factor.

    There’s no reason to overcomplicate what each factor means.

    Here’s all you need to know:

    Payment history reflects whether you consistently make on-time payments.

    Amounts owed, credit utilization rate, and total credit usage refer to how much of your available revolving credit you are currently using.

    Revolving credit mostly refers to credit cards, but could also include loans like a line of credit.

    For example, if you have a credit card with a monthly limit of $1,000, and you are currently charging $300 per month on that card, your credit utilization rate is 30%.

    To maximize your credit score, aim for using 30% or less of your available credit. This ratio applies to each individual account and to your total account balances.

    Length of credit history refers to how long various accounts have been open.

    The longer the accounts have been open, the better your score will be.

    Credit mix looks at what types of loans you have open.

    Generally, lenders prefer to see a variety of loans, like credit cards, auto loans, and mortgages.

    New credit refers to how many loans you’ve applied for recently.

    Applying for too many loans in a short period can negatively impact your score since you may seem desperate for loans to fund your lifestyle.

    What factors are not considered in your credit score?

    Credit scores do not take into account personal information like race, gender, age, or marital status.

    Credit scores also do not consider income or employment history.

    Keep in mind that while personal information or employment history is not a factor in your credit score, it certainly will be considered as part of your application by lenders.

    For example, mortgage lenders and landlords will want to confirm your history of steady employment and income before entering into a financial relationship with you.

    Don’t get caught up in precisely how your score is calculated.

    FICO and VantageScore provide the above information as general guidance. However, each of our credit scores is determined on a unique set of circumstances that changes over time.

    While these factors are generally considered for everyone, specifically how each factor is weighed varies for each of us.

    As FICO explains:

    Your credit report and FICO Scores evolve frequently. Because of this, it’s not possible to measure the exact impact of a single factor in how your FICO Score is calculated without looking at your entire report. Even the levels of importance shown in the FICO Scores chart above are for the general population and may be different for different credit profiles.

    Like we mentioned before, it’s important to not get hung up on the different methodologies that each scoring service uses. For the most part, your score won’t vary significantly from one service to another.

    The key point is to pay attention to the general factors that impact your score but understand that your score is always changing. Don’t waste your energy trying to decipher how much weight is given to each factor.

    How to check your credit score.

    These days, it’s easier than ever to monitor your credit score.

    Most major banks offer free credit scores to their customers.

    You can also sign up for credit monitoring, including credit scores, with the major credit bureaus, Equifax, Experian, and TransUnion. Note that only some services are provided free of charge.

    Of course, there are also no shortage of apps and websites providing similar services, sometimes free and sometimes for a price.

    If you’d like additional guidance on how to obtain your credit score, please reach out on the socials or by replying to our weekly newsletter.

    What should I do instead of obsessing over my credit score?

    Instead of obsessing over your credit score, focus on the strong financial habits we discuss regularly in the blog.

    You should not have to worry about your credit score if you:

    When you can make these habits part of your regular life, your credit score will automatically rise along the way.

    Look at credit scores from a potential lender’s point of view.

    I hope this goes without saying, but lenders are in the business of making money. They make money by gauging risk. The lower an applicant’s credit score, the more the lender’s risk increases.

    When the lender’s risk increases, it may decide to not lend you money. Or, it may choose to lend you money and charge you a higher interest rate to compensate for that higher risk.

    The same logic applies when other entities besides lenders are reviewing your credit score.

    For example, an employer may check your credit score to determine your level of trustworthiness before offering you a job.

    A landlord may check your credit score before agreeing to rent you an apartment to confirm whether you are likely to make the required payment each month.

    Always remember why credit scores are used in the first place.

    If nothing else, remember why credit scores are used in the first place:

    Credit scores are used to measure how risky it would be for someone else to enter into a financial relationship with you.

    In other words, can you be trusted with money.

    If you have a history of not making on-time payments, or not paying loans back, that indicates you are not responsible with money.

    When you are using up most of your current credit and carrying high balances, that demonstrates that you have a hard time limiting your spending.

    If you are constantly applying for new credit, it shows that you may be dependent on credit to fund your life.

    In any of these scenarios, the risk of entering into a financial relationship with you increases.

    Credit scores are especially important before big purchases.

    If you have a big purchase coming up, like buying a home or a car, it’s important to have your credit score in a good spot before applying. This is because your credit score will impact the interest rate you are offered.

    For a big purchase, even slight variations in the interest rate can make a huge difference.

    Because it’s normal for your credit score to change frequently, it is worth waiting to apply for that loan until after you’ve improved your score.

    The best ways to improve your score in the short term are to pay off debt and avoid applying for new credit.

    By paying off debt, you’ll improve your payment history and your credit utilization rate, two of the most important factors in your score regardless of scoring method.

    The best thing you can do to avoid the costly consequences of a poor credit score is to implement the personal finance fundamentals we routinely discuss in the blog.

    Have you ever needlessly obsessed over your credit score?

    Let us know what that felt like in the comments below.

  • Why Credit Reports are So Important

    Why Credit Reports are So Important

    I first learned about credit when I was in law school. My teacher wasn’t a professor, though.

    My teacher was a surprisingly pleasant debt collector.

    I spoke to this debt collector after breaking my wrist snowboarding.

    For the second time in a year.

    Let me explain.

    About six months earlier, my friends and I took a road trip to go snowboarding in Wisconsin. I had never been to this location before and wanted to explore the entire ski area. After a few loops on the main run, I found my way to the terrain park.

    My plan was to scout out the terrain park and report back to my friends. I must have forgotten the plan as I approached a jump that I had no business approaching. That turned out to be a mistake.

    Heading towards the jump, I had too much speed and, for lack of a better word, panicked. My friend reported afterwards that as soon as I jumped, my body and snowboard turned parallel to the ground like I was lying in bed.

    After all these years, It almost seems peaceful to picture myself lazily flying through the air on a beautiful, blue sky, sunny day.

    Almost.

    To state the obvious, this was not a good position to be in since I needed my feet and snowboard to hit the ground first and land safely.

    I ended up landing on my backside with my hand and wrist hitting the ground first. The unpleasant result was a trip to the emergency room and a broken wrist.

    My reputation for having fragile wrists was secured.

    OK, back to the debt collector.

    A few weeks after returning to Chicago, I received a bill in the mail from the emergency room for approximately $200.

    I didn’t understand why I was receiving a bill since I had insurance and provided that information to the emergency room. I figured it must have been a mistake to send me a bill, and that my insurance company would pay for it.

    So, I crumbled up the bill and threw it in the trash.

    Healthcare and medicine. Medical and technology. Doctor working on digital tablet on hospital background illustrating how I first learned about the importance of credit history.

    Before you shake your head, remember that I was still in school and on my parents’ insurance. This was my first interaction with a medical provider where the bills came to me instead of them.

    I didn’t know at the time that even with insurance, I could potentially be responsible for some portion of the bill.

    For the next few months, I continued to receive bills from the emergency room. And, I continued to throw these bills straight in the trash.

    At some point, I received a new type of letter in the mail. This one caught my attention. It was from a collections agency.

    The letter said something to the effect of, “Call us immediately to dispute or pay this medical bill before we are forced to take action against you.”

    The scare tactic worked.

    I picked up the phone and had a surprisingly nice conversation with the debt collector. The debt collector explained how the collections process works and the potential impact failing to pay would have on my credit report.

    Credit report?

    Never heard of that before. Don’t think I have one.

    After hanging up the phone, I did some research and realized the debt collector wasn’t scamming me.

    I certainly did have a credit history, as reflected in my credit report, that I needed to be mindful of.

    I wrote a check to pay the bill the next day.

    This is how a broken wrist and a debt collector first taught me about credit reports.

    What is a credit report?

    As we learned in our post on using credit the right way, credit refers to an agreement to borrow money with the obligation to repay that money later, usually with interest.

    Credit also refers to a person’s trustworthiness or history of repayment.

    A credit report is a document that tracks that history of repayment, as well as the current status of any loans you’ve taken out.

    Your credit report will typically include:

    • Personal information (name, social security number, current and former addresses)
    • Credit accounts (current and historical accounts, including credit cards and any other loans)
    • Collection items (missed payments, loans sent to collections)
    • Public records (liens, foreclosures, bankruptcies)
    • Inquiries (when you apply for a new loan)

    Every time you open a loan, like a credit card, auto loan, or mortgage, it will appear on your credit report. Likewise, whenever you make a payment or miss a payment, that information will be reflected on your credit report.

    When someone has “good credit,” it means they have a reliable history of repayment. When someone has “bad credit,” it means they have not previously demonstrated a reliable history of repayment.

    Remember this key point: your credit report represents a complete picture of your interactions with credit over an extended period of time. Your credit report will include information about you going back years and years.

    This means that the information reflected on the report will follow you for the long term. Any negative information on your credit report will typically stay on your credit report for 7-10 years, depending on the credit reporting agency.

    What is a credit reporting agency?

    In the United States, there are three credit reporting agencies:

    • Equifax
    • Experian
    • TransUnion

    By law, you are entitled to receive a free copy of your credit report from each credit reporting agency every year.

    To do so, simply visit annualcreditreport.com.

    If you haven’t obtained your credit report recently, I highly encourage you to do so.

    Regularly checking your credit report is the best way to make sure that nobody has fraudulently opened any accounts using your social security number. It’s also the best way to monitor all the loans you are currently responsible for.

    Believe it or not, it’s not uncommon for people to forget about loans they have previously opened.

    Did you ever go to a Cubs game in college and sign up for a credit card just to receive a free XXL white t-shirt with a blue W on it?

    No?

    Uhh… me neither.

    How about signing up for a new credit card while making a purchase at your favorite store to save a whopping 10% that day?

    You may never end up using these credit cards and completely forget that you opened them. They’ll still appear on your credit report, and you are still responsible for those credit cards.

    Is a credit report different from a credit score?

    Yes, credit reports and credit scores are different.

    We’ll soon discuss credit scores in detail. For now, understand that a credit score is a number calculated based on your credit history that represents your present day creditworthiness.

    Your credit score captures a moment in time. That means it will change over time, sometimes quickly and dramatically.

    Unlike a credit score, your credit report does not change quickly. Like we mentioned earlier, any negative information on your credit report will typically stay on your credit report for 7-10 years.

    Why does my credit report matter?

    We typically rely on our ability to borrow money to make our biggest purchases in life. When you take out a mortgage or finance a car purchase, you are relying on your ability to borrow money to make that purchase.

    In these scenarios, lenders will “pull your credit” or do a “credit check” before agreeing to give you a loan.

    If you have a history of responsibly borrowing money and paying it back on time, a lender is more likely to lend you money.

    On the other hand, if you have a history of falling behind on payments, a lender may choose to not lend you money.

    Or, a lender may agree to give you a loan and charge you a higher interest rate to compensate for the increased risk. This could end up costing you lots of money.

    Poor credit history can lead to lost opportunities.

    Besides just financial consequences, a poor credit history can also lead to lost opportunities.

    As an example, it’s common practice for landlords to check an applicant’s credit history before renting them an apartment. Most major rental property search websites, like Zillow and Apartments.com, offer credit checks as part of the standard application process. My wife and I require a minimum credit score for all potential tenants.

    It makes sense why a landlord would pull an applicant’s credit. When you rent an apartment, you are signing a contract (a lease) to pay a predetermined about in exchange for a place to live.

    Landlords rely on those rent payments to pay for the property’s mortgage and upkeep. These rent payments can also directly impact the landlord’s livelihood.

    It should be no surprise that landlords are hesitant to rent apartments to people who have a poor track record of paying for things.

    Just as a landlord is sizing up your ability to pay the rent each month, other lenders, like a car dealership or mortgage lender, are sizing up the likelihood you can repay its loan.

    Don’t ignore your credit history.

    Have you checked your credit report this year?

    My wife and I check our reports at least once per year to make sure there are no red flags.

    Fortunately, I realized my mistake with the debt collector before that red flag ended up on my credit report.

    If I hadn’t, I would have seen that negative mark on my credit report for 7-10 years. This would have severely impacted my ability to qualify for mortgages and grow my real estate portfolio.

    I’m glad I learned that lesson about credit reports.

    I’m also glad that I haven’t been back to a terrain park since law school.