NEWS: The latest figures from the US Federal Reserve, released on January 7, showed that by the end of 2021 Americans owed nearly $1 trillion on credit cards and were paying $120 billion in interest.
WHAT IT MEANS FOR YOU: A friend recently complained to me that even though she had more than five figures in savings, her credit score of around 740 was still down a few points. This prompted me to ask around and I found that most people had only a vague idea of what a credit score is let alone the impact it has on the credit score. money they have in their pocket.
First of all, a credit score is not a measure of wealth. My friend is obviously good with her money – a credit score of 740 is not a bad thing. But his savings account has nothing to do with that number. You can be the poorest person in the room and still have the best credit score.
A credit score is about how you manage credit, including repayment. The impact of your habits can also have a huge impact on the amount of your monthly credit card payments, the type of mortgage you can get and more.
Three rating agencies – Experian, Transunion and Equifax – use the scores measured by Fair Isaac Corp. (FICO) and Vantage to determine your ability to manage credit. Scores range from 300 to 850, and you don’t reach “good” until 620 or more. You want to shoot for over 700, and you’re in trouble if you’re below 620.
The higher your score, the less interest you pay on credit cards, car loans, mortgages and insurance premiums. You also have more options when buying a house or a car, pay fewer fees, and generally pay less for everything. The philosophy behind “a low score pays more” is that lenders and other businesses want to make money. A low score means you’re a bad risk because you haven’t paid your bills on time and you’re too reliant on credit cards, which means they don’t know if they can count on you for them. to pay.
Your score may change each week, depending on how you use credit. The good news is that this means you can start working to improve your credit score now.
The high cost of a low score
The difference between a credit score of 620 and a 720 could be 5, 10 percentage points or more in interest on a credit card. If you think that doesn’t make much of a difference, consider this:
Say you have a credit card balance of $4,000 and a credit score of 720. Your interest rate will be on the lower end, say it’s just below the 16% average. A minimum payment of interest and 1% of the balance is $93.33. If you only pay that (and no longer load onto the card), it will take you 246 months (20 years, six months) to pay off the card. You will pay an additional $792.87, for a total of $4,792.87
Your friend has a credit score of 670 and her card has 20% interest and a balance of $4,000. With a minimum monthly payment of $106, it will take her 255 months (21 years, three months) to pay it off, and she will pay $2,056.77 in interest, for a total of $6,056.77.
Your other friend also has a balance of $4,000, but missed some payments. Her credit score is therefore 605 and she pays a penalty rate of 29%. His minimum payment is $136.68 and it will take him 272 months (22 years) to pay off the card. By then, she will have paid $4,938.32 in interest, for a total of $8,938.23 on the original balance of $4,000.
You probably didn’t know that a minimum payment is mostly interest. These examples represent the lowest allowed minimum, and some cards may have a minimum that covers more of the principal. But it’s a great way to see how much a lower credit score will cost.
If you are 60 days late on payments, your credit card company may start charging a penalty interest rate, usually around 29.9%.
Credit card companies are required by law to show on your monthly statement how long it will take you to pay it off with the minimum and how much you will pay during that time.
How to increase your credit score
So it’s pretty clear that the lower your credit score, the more money you’ll have in the short and long term. Your monthly payments will be lower, you’ll pay them off faster, and you’ll pay less over time.
Although you’ve seen apps that promise to help you boost your credit score, they only work if you do the same thing you would without them. Here’s what you can do right now to increase your score:
- Pay on time. The absolute biggest factor that determines a credit score is on-time payment. Missed payments cause credit scores to plummet. This counts for a third or more of a credit score.
- Keep “credit utilization” below 30%. The amount of credit you use relative to your limit is the second most important factor. If you have a limit of $3,000, you want your balance to be $1,000 or less. The closer the balance is to the limit, the lower your credit score.
- Don’t apply for every credit offer you receive. “Hard draws” on your credit report count towards your score. When a credit card “pre-approves” you for a card, it’s a “nudge” and doesn’t count towards your score. When you go online to apply for this offer, the company makes a big effort, more than six or so in a two-year period will lower your score.
- The longer you’ve had an account, the better. This shows that you have an established credit history. The shorter your average credit history, the more suspicious lenders are of you.
- Credit mix. Similar to the length of your credit history, the more different types of credit you have – credit cards, mortgage, etc. – shows lenders that you have experience in effectively managing different types of debt.
Hacks to increase credit score
So paying on time, keeping balances low, and not going crazy applying for cards is the way to improve your credit score. But it’s another to make it work. This means taking charge of your finances. Sorry. But it’s not as difficult as it seems.
- Create a budget and stick to it. I know. What pain! But it can be as simple as listing your monthly bills and income on a Google doc or notepad, and checking it frequently to make sure you’re on the right track. There are all sorts of budget apps available, but you still have to get the job done. Most apps require you to add all of your account information before you can track. If that seems overwhelming, then do something simpler. The important thing is to know how much you owe each month, how much you earn and pay the bills you owe. You can’t do that if you don’t watch it.
- Set automatic payment of your bills. When bills are automatically paid from your bank account, you don’t have to remember to pay them. However, you must remember that they come out of your account. This is where the budget comes in.
- Set automatic payment for your credit card minimum payments, then pay more during the month. Paying your credit card bills on time is essential. Now you know what the minimum payment is costing you, so make sure the minimum will be paid, then when you have some extra cash, carry on for the month and pay some more, too.
- Try not to use credit cards and when you do, pay off as much of the balance, or all of it, as possible. Very difficult if you don’t have a lot of money coming in, but not impossible. Be hard on yourself about cutting expenses. It won’t be long before you find more money in your pocket as your balances drop.
- Check your credit report. Credit reports are available free of charge from all three credit reporting agencies weekly until the end of April (a COVID concession). Traditionally, you can get free copies once a year. They are available on annualcreditreport.com. It is estimated that up to 25% of credit reports contain errors. You can have them deleted. You can also add a note to explain any credit issues you may have had in the past.
Many banks and credit card companies offer weekly credit score updates to customers. If yours does, opt-in. Some also provide an analysis of why your score changed. Now that you know your credit score, you can use this information to your advantage and start living a less expensive life.