Understand your credit score
A credit score, also known as a FICO score, is a number that represents your credit worthiness. A credit report is a summary of all the credit activities used to generate your credit score. The score gives lenders or financial institutions your level of default risk: the risk of you not paying back what you owe. Your credit score is generated by the credit bureaus (Experian, Transunion and Equifax) based on reports from financial institutions. The higher the credit score, the lower the risk.
There are multiple credit scores for a given person depending on the industry:
one credit score for a car loan ; one credit score for a mortgage ; one credit score for opening an account; etc.
The scores range from 250 to 900. There is also a “general purpose” credit score ranging from 300 to 850. Your credit score impacts your loan or mortgage interest rates and also determines the kinds of credit cards you can apply for. As long as your credit score is above 740, you should have access to the best interest rates.
Build a credit score
If you have no credit score, you can apply for a secured credit card. The cash you will deposit upfront will be your credit limit. You would use this card like an unsecured credit card and pay your expense monthly. The cash is used as collateral if you miss a payment. Make sure that the financial institution reports to all three credit bureaus.
You can also apply for a credit builder loan. You apply for such a loan for the sole purpose of reimbursing it. You cannot use the money borrowed- the lender keeps it. The only purpose of this loan is to build a credit history.
You can become an authorized user on someone else’s credit card. This person can be anyone – typically a spouse or family member. However, verify that the financial institution will report the activity on the card to the credit bureaus in your name as well as the name of the card holder. This is not always the case for authorized users.
Know and track your credit score
You should track your “general purpose” score and credit report to make sure that no mistakes are made. Keep in mind that this score isn’t precisely the same score that a lender will receive, but it’s a good ballpark score.
Credit Karma – www.creditkarma.com – allows you to check your score for free multiple times per month. It also gives you the details of what changed and why.
The site www.annualcreditreport.com is the only official source where you can check your score once a year for free. There are many other websites where you can check your credit score for free. The bottom line is that you should never pay to find out your credit score.
Protect your credit score
Low impact Hard Inquiries
When you open an account, apply for a loan, or apply to rent, the lender or landlord will pull your credit score. This action is called a hard inquiry and it will decrease your credit score. You will also get a hard inquiry if you apply for multiple credit cards at once because it suggests to the credit bureaus that you are short on cash. On the other hand, multiple hard inquiries made when you are shopping for a loan/mortgage will typically be considered as one inquiry as long as they are done within a span of 45 days. Hard inquiries stay on your credit report for two years, with the impact decreasing during that time. Checking your credit score via free websites like credit karma or asking for a credit limit increase are known as soft inquiries – those don’t impact your credit score.
Total number of accounts
Your total number of accounts is the number of accounts you have ever had, including closed accounts. An account is a line of credit: it can be a loan, a mortgage, or a credit card. Lenders want to see that you manage(d) your accounts responsibly. You should have a good mix of accounts, but aim to find the right balance between having too many accounts (hard to manage) and too few (hurts your credit score).
The age of your account is another parameter in the calculation of your credit score: the older the account, the better the score. The credit bureaus take the average age of all your accounts. If you are considering closing an account, keep that in mind – it’s better not to close your oldest account.
Derogatory Marks are indications of negative financial events (bankruptcy, foreclosure, late payments, etc). They have a long-lasting effect as they can stay on your credit report for 7 to 10 years.
Credit Utilization is the ratio of your monthly spending to your credit limit. The general recommendation is to stay below 30% of credit utilization, but my recommendation is to stay below 10%. For example, if your credit limit is $10,000, try not to spend more than $1,000 on the credit card. One way to decrease your credit utilization is to pay your credit card balance twice per month instead of once per month. You could also ask for a credit limit increase: it’s free, it doesn’t impact your credit score, and you can usually do it online.
It is important not to miss or be late for any payments, even for small ones, because that would significantly hurt your credit score. I advise my clients to set up automatic payment for every bill. It’s easier to correct a mistake in a bill that has been auto-paid than it is to recover your credit score following a delinquent payment.