MoneyMonday: Understanding Credit and Your FICO Score

Hi. I’m Janel Cross. One of your MoneyNav coaches. Welcome to this workshop, Understanding Your Credit. How to fix it, build it, and protect it.

If you’ve attended another session, you’ve been introduced to the three stages of financial wellness. If this is not familiar, plan to join an Intro to MoneyNav session offered at the beginning of every month. Also, our Money Milestones course takes a deep dive into these stages.

Understanding Your Credit is a Stage 1 Financial Safety course.

Before talking about how to improve your credit score, let’s review how it works. First, a credit score is just a numerical expression of a person’s creditworthiness, and the higher the better when it comes to this metric. To determine your creditworthiness, creditors use your score to predict if you’d be a reliable investment. Your score determines whether you qualify for a loan, what interest rate you’ll pay, or how much credit you’ll receive.

Credit scores range from 300-850.

Considering, few Americans land in the “Excellent” range, chances are there’s something you can do to improve your score. Having a good credit score is important because it impacts things like getting approved for credit cards, and loans, and qualifying for lower interest rates. In this workshop, we walk through five things you can do to move your score toward excellent.

https://www.valuepenguin.com/average-credit-score 

Equifax, Experian, and TransUnion are the three main credit bureaus. They collect your consumer information and then provide the information to creditors in the form of a credit report which contains your credit score also called your FICO score.  

The five most influential components of your FICO score are your payment history which counts for 35%, amounts owed or how much of your credit line you’ve used is 30% of your score, length of credit history accounts for 15%, types of credit or credit mix are 10%, and establishment of new credit available contributes 10% to your score.

Making payMents on time is the biggest contributing factor, with your payment history accounting for 35% of your total score.

For this reason, the first step to improve credit is the most obvious: pay your bills on time. Missing even one due date by a day can negatively impact your score. Delaying 60 or 90 days can pull your score down significantly. When creditors look at your score and see a missed installment it's like throwing up a red flag. They'll see the missed payments and assume you are a risk. They could deny your credit or increase your interest rate. Even worse, those missed payments will linger on your credit report for seven years, even if you close the card or pay off the balance.

If you've only missed one payment it doesn't hurt to reach out to your billing companies about removing the missed date from your record. If you have a track record of making payments on time, they might be forgiving.

A good habit is to set up automatic payments or reminders to pay the minimum well before the due date. Then make additional payments, and ideally pay off your balance, when you settle your finances. I do this monthly, but some folks do it every pay period. The frequency is up to you, but we recommend you balance things out at least once per month.

Our second good habit is to correct any errors on your credit report as soon as possible.

Everyone is entitled to receive a free copy of your report once annually from each of the three bureaus. Your credit report contains all the information used to calculate your score. Credit bureaus are not perfect so they can and do make mistakes.

The most common errors you may find are identity mistakes, incorrect account details, and fraudulent account errors. An identity error can range from having the wrong phone number to a more troublesome issue of mixing up your score with someone else's.

The second error that will affect your score is having incorrect account details. For instance, if closed accounts are reported as open or if open accounts have the incorrect credit limit listed.

The most serious mistake is someone trying to steal your identity and open lines of credit with your information but without your authorization. Check the credit lines reported and make sure you opened them yourself.

If you identify an error, dispute it immediately with the credit bureau that is reporting it incorrectly. You'll need a copy of the credit report containing the error and supporting documentation. Taking the necessary steps to correct errors can be time-consuming but can make a huge difference in your score.

How old is your credit history? Some people get a credit card as soon as they can and others wait until they need it, but the truth is the age of your credit has a big impact on your score. Creditors want to see you’ve had credit lines open and are making payments. The longer the account is open and in good condition, the better it is for your score. We will talk more about this in a minute, but this is a reason to consider opening a credit card for responsible young adults.

One big misconception about debt is that closing out old credit lines will help your score, but it can have the opposite effect. Keeping old accounts open and functioning with a history of on-time payments allows your payment history to grow and, in turn, improves your credit score.

If your past debt mistakes are severely bringing your score down, then you may consider closing the account. Be aware, those mistakes will still carry on your report impacting your score for at least seven years.

The longer your history of good debt usage, the better your score. So keep good debt lines open as long as possible.

What's your credit utilization ratio? Your credit utilization ratio is simply the amount of outstanding balances on all credit cards divided by the sum of each card's limit. The lower the percentage the better your score.

Creditors prefer to see a utilization ratio of 30% or less, but there is no magic percentage when it comes to the ratio. Bringing down your ratio can have a positive impact on your credit score.

If your ratio is over 30% there are ways to lower, it. For starters, try to pay off your balances in full every month or call the lender to increase your credit limits.

To determine your ratio, you can use online calculators like this one from dollar sprout.

The final way to improve your score is easier said than done, stop overspending. If you reduce spending, it'll reduce the amount of debt to repay and make improving your score easier.

Building up debt is more than overspending though. For example, did you know if you agree to cosign for someone and they default on that loan it will reflect on you and affect your credit score?

If you don't already have a spending plan, now is the time to start one. Check out our Dollars & Sense workshop for more on this topic.

This is also a good time to create a debt reduction plan if you need to. A good source is Credit.org. They offer credit and debt counseling services at no cost to you. Also, check out our Living Debt Free workshop.

So far, we’ve focused on ways to improve your score. But what if you are just starting out? Building credit can be like a “chicken and egg” riddle. You need a credit history in order to obtain credit but how do you get credit without a history?

Banks have created ways to get your credit train started on the right track. There are things like secured credit cards that are backed by an account that the lender can access if payments aren’t made on time. There are also programs called credit builder loans that help build your credit.

There are some financial transactions that don’t automatically track your credit history including rent and utility payments. If you visit websites like rentalkharma.com and renttrack.com, you can get credit for on-time payments.

Another important component of the FICO score is your credit mix. So, you don’t want to just have credit cards or just have a mortgage. A variety of credit and loan types is good for your score.

This includes credit cards, mortgages, auto loans, student loans, and bank lines of credit.

As we wrap up today, let’s take a moment to see just how much credit impacts our money resources. This chart shows four expenses that are influenced by your credit score: mortgage interest rates, auto loan interest rates, the cost of insurance like car insurance, and credit card interest rates.

You can see how folks with higher scores pay less. And the difference can be significant. Look at the difference in interest rates for a car loan or credit card for someone with poor credit compared to another with an excellent score.

And those interest rates translate into real dollars that you’ll have to give to a lender instead of spending on yourself. The difference between fair and excellent credit can cost you $100,000 more for your mortgage.

So, let’s review some good habits that will get and keep your credit on track…

That wraps up this Understanding Your Credit workshop but don’t stop your wellness journey here. Keep taking the best next step. Google is full of advice. So are family and friends. But not all advice matches your situation. We are here to help you figure out what the best next step is for YOU, right NOW, so you wind up where you want to be.

A great next step is to complete your MoneyNav assessment. This questionnaire takes about 5 minutes and results in a series of To Dos, or best next steps, that are built into your personalized MoneyNav dashboard. For a link, email yourfinancialcoach@moneynav.com for an assessment link.

You can also schedule to meet 1-on-1 with a coach.

Be sure to keep joining us for MoneyMondays. To view upcoming sessions and to sign up, visit www.moneynav.com/moneymonday.

On behalf of the entire MoneyNav team, thanks for joining me today! If you have questions on this topic or another, please reach out. We look forward to connecting with you.