Credit: Why it is so Important for Financial Success
What is a Credit Report? A Credit Report is a summary of different kinds of data compiled from your bill paying history, loans, current debt, and other financial information. It lists where you have worked, lived, and whether you have been sued, arrested, or filed for bankruptcy.
Credit Reports help lenders decide whether or not to extend you credit and what interest rate to charge you. Insurance agencies, potential employers, and rental property companies may also use your credit report to make decisions about you.
What can you do to build your credit? Your credit score is broken down into these percentages:
1.35% Payment History. Pay your bills on time. This one is the most important because it makes up a large percent of your final score. One 30-day late on your report will lower your score significantly.
2.30% Amount you owe (Capacity). Limit the amount you owe on credit cards. The limits on your credit cards play a big role. If you have just one card with a $5,000 limit and you keep a balance of $4,000, you are reaching the capacity of your credit limit. This is considered escalation of debt and your credit score will go down. If you have two credit cards and each has a limit of $5,000, you have a capacity of $10,000. You would be able to spread that balance of $4,000 between the two cards without significant impact.
3.15% Length of credit history. If you can, don’t close old accounts. Leave them at a $0 balance, forget about them, and put the cards in a safe place or cut them up. Your oldest Trade-line (loan history) is important. This means you’ve had a longstanding relationship with a credit company. By having this relationship, you are rewarded with a positive credit score for being dependable.
4.10% Types of credit. Secured loans as well as unsecured loans are important for your credit score. A secured loan, such as a car loan, is a fixed payment that you pay the same amount every month. If you make this payment on time every month, it shows dependability and the ability to pay. A credit card is an unsecured loan. You have the option of paying the whole amount off every month or just a portion. Having both of these types of credit is important because it gives lenders the whole picture of your stability.
5.10% New Credit. Don’t open multiple loans in a short period of time. (New credit cards, a car loan, etc.) Escalating debt.
What does this mean to you? Let’s put it into dollars saved and dollars spent. Here’s the scenario: You apply for a $25,000 car loan and you have a credit score of 750. This would put you in the top tier and the best rate available for this loan. For your credit score of 750, the lender offers you a rate of 3.49% X 60 months = $454.68 payment. You will pay $2,280.90 in interest for the life of the loan. That sounds pretty good, right?
But let’s say that your score is a bit lower and they offer you a 6.49% X 60 months = $489.04 payment. You will pay $4,342.20 in interest for the life of the loan. Your payment is higher and you will pay more interest.
Now for the worst case scenario: Your score has plummeted. What are you able to get in a loan? You could possibly qualify for 17.99% X 60 months = $634.70 payment. You will end up paying $13,081.98 in interest for the life of the loan and that’s only if you qualify.
Look at the difference in rate, payment, and the overall amount you would have to pay. Now imagine that same thing happening in a 30-year Mortgage with a $250,000 loan!
Credit is important for all of us. The right credit will go far in building the financial success that is just waiting for you. Be credit savvy, be smart!