By Brad Wright, CFP
Now that the celebrations and giveaways are behind us, it’s time to focus on, uh…paying the bills (and avoiding COVID). The sooner you pay off your credit card debt, the better.
Whether you realized it or not, you started building your credit score with your first credit card or loan. Your score can go up or down and will follow you for life. It becomes a factor when applying for a mortgage or auto loan, renting an apartment, purchasing an insurance policy, and even applying for a job. I hear more and more stories of young couples checking each other’s credit scores before getting into a serious relationship because money is a big part of divorce.
Here are five contributors to your credit score.
- Payment history: Pay your bills on time because your history accounts for 35% of your credit score.
- Amount: This contributes 30% to your score and refers to your credit utilization ratio: how much of your credit limit are you using? If you max out all of your credit cards, it will impact your score and lower it.
- Length of story: The longer your credit history, the better, assuming it’s positive. The age of your oldest line of credit and the average age of all your lines of credit are added together to make up 15% of your score. Keep in mind that closing a credit card could negatively impact your credit score. In effect, your total credit limit decreases and your credit utilization ratio increases. It’s not generically true that you shouldn’t close credit cards that no longer make sense to you, but be careful when closing them. If you are about to apply for a loan, you may want to wait until the loan is approved and funded.
- Credit mix: This data point represents 10% of your overall score. It is a combination of revolving credit, such as credit cards, and installment credit, such as mortgages and student loans. Having a bit of both can help your score.
- New credit: This includes the last 10%. New credit is a combination of new accounts opened in the past year and the time since you opened your most recent account. New credit is tracked by the frequency of inquiries on your credit file. Each time you apply for a loan, the lender runs your report and it counts as an inquiry. For example, if you walk into five car dealerships to price your next car, each dealership will want to run your report. When you proactively check your own score on AnnualCreditReport.com or directly with the three credit bureaus, it does not count as an inquiry, and you should do so annually.
Check your credit score
It’s important to sign up for a credit monitoring service with one of the three bureaus or check your credit score annually to make sure there are no errors and no one has tried. to steal your identity. When I applied for my first mortgage in 2004, our mortgage broker called me and said I had outstanding debt on my report. When he sent me the report, I quickly noticed that the associated debts were tied to a different social security number than mine but were somehow included in my report. It was definitely a mistake and one that my mortgage broker was able to fix by calling the reporting agency. If I had kept an eye on my credit report, I probably would have found the error before applying for a mortgage, which would have made the process a little smoother.
You can check your score in the following ways:
- AnnualCreditReport.com: Federal law allows you to obtain a free copy of your credit report every 12 months from each credit reporting agency.
- Alternatively, you can also contact the three individual offices directly:
Understand your grade
Here is the rating that your credit score translates to:
- Excellent: 800 and above
- Very good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: 579 and below
It makes sense (and saves money) to pay your vacation bills on time and in full if you can. Cheers to a happy and healthy New Year, and an increase in your credit score.
About the Author: Brad Wright, CFP®
Brad Wright, CFP®, is co-founder of Launch Financial Planning, LLC, a fee-based company located in Andover, MA. He is a frequent contributor to WCVB-TV and Mix 104-1 Radio. Brad is past president of the Financial Planning Association of Massachusetts. Learn more about Brad at www.LaunchFP.com
The reviews written here are for general information only and are not intended to provide specific advice or recommendations to any individual.
The foregoing information was obtained from sources believed to be reliable, but we do not warrant that it is accurate or complete. All opinions are those of Brad Wright.