This blog post is part of the Financial Literacy series. This information could be helpful to new educators and young adults and has more generalized information that most AskKenna Resources. This is purely anecdotal. Please remember that I am not a financial advisor and this information is provided at your own risk.
Credit scores can be mystifying and many people hem and haw about whether they are very important once you can maintain a score above 650. Basically you’re given a score between 300-850. The national average varies between 640-700 usually. A score of 700 or more is considered “good,” and 800 or more is “excellent.” Having a good credit score shows lenders that they can trust you to take on a loan a pay it back with regular and full payments. Having a lower score suggests that you may struggle to repay loans and are therefore a riskier investment. For you, it matters because with a better credit score you will be offered loans at a lower interest rate, potentially saving you hundreds and thousands of dollars, depending on what you’re borrowing and how long for. Let’s look at an example.
Mary
Credit Score: 805
Buying a house; needs a loan of $300,000
Will repay over course of 30 years.
Offered 3.7% interest rate by her bank
Sarah
Credit Score: 605
Buying a house; needs a loan of $300,000
Will repay over course of 30 years.
Offered 4.9% interest rate by her bank
In Mary’s scenario, she will end up paying $497,106 for her $300,000 loan over the course of 30 years. Sarah will pay $573,185. Think about what good you could create in the world with an extra $76,000! Just for fun, let’s look at the 15 year rate. If Mary and Sarah could afford paying a higher mortgage payment each month, they would make those payments for only half the time, saving Sarah $149,000 and Mary $106,000. Yes, interest can feel tricky, but the more you play with the numbers, the more comfortable you’ll get. There are a lot of calculators online, so spending some time putting different scenarios in may help you see how your credit score will help or harm you. Be careful with some of the calculators though; many are sponsored by mortgage companies and banks hoping to sell you a product.
So how is your credit score factored?
The biggest factors are how long you’ve had your credit cards for, how much debt you have on them, and your payment history.
Length of credit history—this is the average of all your credit cards and other banking products such as student loans and mortgages. This is why even if you don’t want to use a credit card for your daily spending yet, it’s good to get one early and hide it somewhere. If you were to get a credit card at 18, another at 22, and a third at 25, then when you turned 28, your credit history would be an average of about 6 years, which is seen as “good” on your credit score and could help you purchase a home or car at a better interest rate.
Available credit—for the most part, you want to have much less on your card than they allow. Using less than 25% of your available credit is a good goal, so if you have two credit cards with a total limit of $10,000, you want to try and put $2,500 or less on them each month, and of course, make sure you pay the bill in full each month so that amount doesn’t creep up. If you’re using credit cards responsibly, calling your company and asking for a credit increase, or applying for a new card are ways to increase your available credit.
Payment history—this is a summary of how regularly you make payments. Not missing payments is essential to keeping your credit score high. Even if you can’t make a full payment on your card, you simply must make the minimum payment if you want to keep your credit score healthy. If you’re struggling to pay your credit card each month, it’s time to revisit your budget and make sure you’re prioritizing correctly. You can also call your credit card company and ask to move your due date if your payments are often due right before payday, but that will only be a temporary fix if you’re swiping your card all over town!
Other factors in your credit score:
- Inquiries, meaning the number of times a bank is checking your credit report to decide if you need a loan. These usually stay on your report six months to a year and only impact it by a few points. You can keep this factor healthy by spreading out and limiting the number of loans and new cards you apply for.
- Total number of accounts, meaning how many accounts you have. In general, having more accounts in good standing is good, but having too many or having accounts in poor standing will impact your score.
- Derogatory marks—incidents such as being sent to collections or having your identity stolen are part of this factor.
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