For some reason, I thought everyone knew what credit was. Turns out I was wrong. I found this out by simply eavesdropping on some students while riding the train to school (another perk to public transit). I’m not certain how the conversation started but what I overheard wasn’t very pleasant. The statement that stuck out to me the most was something like “You don’t know what credit is? Well, its money that you borrow and then eventually pay it back.” Now, this comment isn’t wrong but she went on to explain credit cards and not necessarily credit or credit history, they never talked about their A.K.A. FICO score.
So let’s talk credit.
Credit “is the ability to obtain a good or a service before payment has been received.” Easy enough. You are using someone else’s money. You use credit more than you think. Just to list a few… credit cards (obviously), mortgages/rent, student loans, and amenities.
Also, people are scoring you on how well you handle your credit.
When you pay a bill, 90% of the time, the company will report that payment to a credit bureau. The Credit bureau will then score you based on the report that was given.
There are 3 credit bureau’s: Equifax, Experian, and Transunion. These guys track your credit history and formulate a score. Usually between 300-850. Actually, each bureau has their own unique score. Experian scores 360-840, Equifax scores 280-850, Transunion 300-850.
Now it doesn’t seem very fair that you can have a lower score with Equifax than you can with Experian. This is were FICO comes into play to save the day!
Fair Isacc Corporation (FICO) has set a standard for all the scoring that occurs. So the three credit bureaus will have their own score and a FICO score. When lenders check your FICO score it will be an average of all 3 FICO scores that have been reported from the credit bureaus.
When you are scored by FICO you will be placed into one of the four categories: Poor/Bad (<649), Average/Fair (650-699), Good (700-749), and Excellent (750-850) credit. You want to be in Excellent, don’t be anything less.
What influences your credit score?
Payment History (35%)
This plays about 35% of your overall score. Thus making it the most important. Payment history is simply the bills you have paid. Those bills can be anything from car payments to utilities. The lender wants to know what kind of paying habits you have. Make this easy on yourself and set up auto-pay.
Amounts Owed (30%)
This is a way for lenders to be able to speculate if you can handle more debt or not. They look at your debt to income ratio, the bigger the gap between debt and income, the more it will hurt your score.
Length of Credit History (15%)
The longer the better…. eh well, if you have been making your payments on time and haven’t had any late payments. A credit account that has been open for 2+ years (with on-time payments) looks good.
Type of Credit (10%)
FICO Scores will consider your mix of credit cards, retail accounts, installment loans, finance company accounts, mortgage, and student loans. If you have multiple types of credit, it looks better than just having a bunch of credit cards.
New Credit (10%)
Although it is good to have multiple types of credit, you want to be careful with how many loans you apply for in a short period of time. Too many applications for loans will look desperate and isn’t appealing to lenders at all. This will hurt your score. It looks even worse if you have a short credit history. When you are just beginning to build up a credit history, I would avoid applying for more than one credit card for at least two years and not applying for different loans for at least 6 months.
Why is this all important?
Have you ever had the thought of buying a house? A business? A car? I sure have, and your credit score is extremely important for all of these. Having a good credit score identifies you as a responsible individual. Sweet.
This ensures the lender that they will be receiving payments from you. Because of this, they reward you for having a good/high score (being responsible). Some of the rewards are as follows:
No need to play the waiting game. When lenders see you have good credit, chances are you will receive the loan you have applied for and avoid more paperwork.
Lower APRs on loans
Hands down the most important reason why you need excellent credit. When you go to take out a loan you will be offered a lower interest rate than if you had bad credit. With good credit, interest rates will be significantly lower (like a 10% difference) when you go to buy your first house, car, business, or refinance student loans. This will save you thousands!
Real quick I copied the chart below from myFICO (the consumer division of FICO) just to give a good idea of how having an excellent credit score is beneficial. The chart shows the difference in APR’s determined by your credit score. When you click on the link it will pop up the “loan savings calculator” and will be defaulted to 30-year home loan. If you want to compare my chart with theirs just to see that I am not lying you need to select the 60-month new car loan. Then you will be seeing the same rates as I have posted.
|How Your Credit Score Determines Your Auto Loan APR (60-month new car loan)|
|Score Range||APR (%)|
|Rates accurate as of Oct. 27, 2017|
“No need for a down payment with good credit!”… Now just because you can, doesn’t mean you should.
You should always do a down payment. Especially with houses, you need to have at least 20% for the down payment never do anything less. By doing down payments you lower the amount of the loan you need to take out. That down payment doesn’t accrue interest either…. your loan will.
For some reason, if you pay responsibly this also means you drive responsibly. Not sure how they have derived that but that’s how they judge ya. By this simple fact, your premiums that you pay should be lower.
Honestly, there isn’t much more to credit then what I have covered. Like what lowers your credit score, what doesn’t lower your credit score, or how to increase your credit score… I think that’s it. If you don’t have any credit history you need to start working on that ASAP. I wish it wasn’t this way but having a good credit score is essential for those big financial decisions down the road.
So did you already know what credit is? Did this help you in any way? Do you have a good credit score? Tell me what you think in the comment section!