I can't remember ever formally learning about credit scores. My understanding came from the bits and pieces of information I collected over the years.
Retrospectively, I realize how much I didn't understand, and how completely in the dark I was when it came to credit scores. But, being in the dark can be a serious mistake that could mean the downfall of your financial well-being.
The truth is that a large part of your financial health hinges on how well you do with your credit score. Your credit score affects many parts of your finances: it can determine whether or not you will be approved for a loan or line of credit; it will affect the interest rate, and may increase the amount that you pay for the loan; it can affect your ability to get a job, and even your ability to rent an apartment.
MY CREDIT SCORE STORY
I had a narrow escape from financial destruction by my credit score. No, I didn't open ten new credit cards, or forget to pay my loan for the past 6 months. The reason why I had a narrow escape was because of one simple reason: I didn't understand credit.
I was buying my very first vehicle. As I sat in the dealership, signing papers to finalize the process, the salesperson was talking, and talking, and talking, about all things I didn't understand. I was 21, and didn't have much knowledge of how the whole car-buying process worked. I basically knew two things: (1) That I needed a loan, because I didn't have $14,000 to fork over; and (2) I had to make my monthly payments to my credit union on time, or else….
Little did I know how detrimental one mess-up could be. I could have taken down my entire financial life if I had been unable to make even ONE payment. My score would have dropped, and that would have affected my ability to be approved for future loans and credit cards. Because I made all of my payments on time (by some lucky streak), my buying power is significantly higher. The scary thought is that I had no clue that I could have completely sabotaged myself with one mistake.
Many people deal with credit on a daily basis, and make HUGE financial decisions without realizing how it can affect them in the long run. Many consumers don't realize that a negative credit score can result in higher interest, which means you can pay much more on a loan than someone with a high credit score. That’s why it’s so important to understand how credit works, before getting into too many situations dealing with it.
Let’s Figure Out Credit Scores Once and For All!
A credit score is a number determined by credit bureaus that determines how likely you are to repay a loan or other line of credit. Lenders, like your credit union or bank, look at your credit score before deciding to give you a loan. Other people, like your employer or landlord, can also pull your credit report (with your permission) to see your score, and determine your “credit worthiness” and whether or not they want to hire or rent to you.
The good news is, you can control your score. Your credit score is calculated based on the following five categories:
- Payment History (35%) If you make all of your monthly payments on time, you’re in good shape! This includes everything from your rent and your car payment, to your utility bills and student loans. Keep in mind that even one late payment can drop your score 75 - 100 points.
- Capacity (20%) This number represents how much of your available credit is being used, or is available. If you are close to maxing out all of your cards, then you look risky. Using only 30% of your available credit will put you in a much better place! (Credit limit of $1.000, use only up to $300).
- Length of Credit (15%) The longer your accounts have been open, the clearer the snapshot of your spending habits.
- New Credit (10%) If you open up lots of new lines of credit in a short period of time, that looks risky.
- Mix of Credit (10%) The different types of credit you have.
What if you don’t have any credit? How do you get a credit score?
The term is called “building credit.” When you start, your score is neither good nor bad. It is nothing. You must use credit to build credit. Two common ways of building credit are with loans and credit cards.
Many people are under the misconception that credit cards are your worst enemy, and you should stay away from them at all costs. This is simply not the case. If you ever want to start establishing good credit, using a credit card responsibly is one very effective way to do that.
How to build credit
- Have a credit card, but use it to buy things you would buy anyway (i.e. gas and groceries)
- Do not let your credit card have a balance. If you spend and pay immediately afterwards, you will not have to pay interest, and you will be showing that you are a responsible spender.
- With any form of credit, pay on time, every time.
- Share secured loans are great way to borrow money safely, and have established credit at the end of the year. (Ask a credit union about share secured loans!)
I think that many people learn about credit after the bad things already happen. Before that, there's no real reason to pay attention, right? Wrong. I learned firsthand that not knowing about your credit score, is about as bad as a bad score.
What Students Learned About Credit Scores!
Recently, at a Financial Fitness Fair at Sacopee High School, credit unions taught students about budgets, credit scores, and expenses. Here are some takeaways students had about their credit scores! If you have an experience that you learned from, or a question about credit scores, please share in the comments!
“I learned that your credit score is imperative to living comfortably.”
“We can start building credit at 18 years old.”
“I learned that you pay almost double with a bad credit score compared to a good score.”
“With a bad credit score, the interest rate for buying a car raises.”