Financial Education Series - Part 1
Are you getting ready for a life change like becoming self-employed, growing your business or making a large purchase? Are you new to the United States or just starting to figure out how credit works? Or are you looking to make a fresh start on your credit history? Having a good credit score can be the difference between opening new doors, leaving you stagnant or falling into the abyss of debt. In the first part of this series of financial education posts, I’ll explain the basics of how credit scores affect your life and how to take control of your credit.
Before I became a full-time, self-employed translator, I worked as a bilingual loan officer at a credit union for 7 years while doing translations on the side and completing my translation studies at New York University. I’ve seen a lot of credit reports, tracked what makes them fluctuate, and have given a lot of credit counseling. Some of this stuff you may already know, but hopefully not all of it.
Credit reports are like a financial CV (or report card) and credit scores are your grade. They can facilitate or hinder doing business, determine how much of a house or car you can be approved for, what kind of job you can get, whether a landlord will accept you as a tenant, what cell phone plans you’re eligible for, whether you need a deposit to open utilities accounts, down payments, and so on. There’s a lot of questionable information out there, and you deserve the truth! It’s kind of a game, so here are the rules…
There are three main credit bureaus (aka: credit reporting agencies) in the United States: Experian, Equifax and TransUnion. Experian has the largest presence in the US. They are actually based in Ireland and operate in the US, UK, Brazil, Russia, India, China, Spain, Chile, Mexico, Argentina and many other countries. What’s crazy is they have the most sensitive data on over half of the world’s population. So although people can cross borders to escape debt problems, it’s probably not forever.
In the US, credit scores range from about 325 – 850, depending on the credit bureau. A good credit score is above 700. An excellent credit score is above 750. In Brazil, scores range from 0 – 1000 with great scores being above 700. In my years of reviewing credit reports, I’ve never seen any credit score lower than 400, nor any that reached the full 850. There is a myriad of factors that determine your score:
Pay on Time
The most important component of your credit is payment history. In other words, make your payments on time! A payment actually needs to be 30 days late for it to affect your score. Yes, banks and creditors may charge you a fee if you’re 5 or 10 days late, but it won’t affect your score until it’s 30 days late. I’ve seen a single late payment make a person’s credit score drop by over 50 points. Late payments do lose their severity after a couple of years. For example a late payment from two years ago won’t affect your score as much as a recent one. Payment history accounts for ≈35% of your score.
Have Credit Available
The second most influential factor on your credit score is how much credit you have available (capacity). For example, if you have a bunch of different credit cards and they are all maxed out, you will have a low score, even if you make all your payments on time. However, if you manage to pay down your credit cards, it will significantly improve your score. To the credit bureaus, having credit available but not in use is a sign of responsible borrowing. The optimal figure to aim for is 30% of the credit limit. For example, if you have a $10,000 credit limit, try to have your balance be at $3,000 or less when your credit is checked. I’ve seen credit scores change by over 50 points from one month to the next just based on changes to credit card balances. Credit capacity accounts for ≈30% of your credit score.
Slow and Steady
The other factors include length of credit (≈15%), accumulation of debt (≈10%) and mix of credit (≈10%). Length of credit refers to how long an account has been open. Having a credit line with good payment history that was established 10 years ago will reflect better than one that was established a year ago. I believe this contributes to the fact that I have never seen a credit score of 800+ for someone who was younger than 50 years old. Accumulation of debt has to do with how many new loans a person has obtained in the past year or so. Someone who takes out a lot of loans within a short time frame is regarded as riskier. Mix of credit is the different types of loans. For example, a person who only has credit cards will have a lower score than someone who has a credit card, a personal loan, an auto loan and a mortgage. Having accounts with finance companies like payday lenders, cash stores, etc. will decrease your credit score.
Don’t Go for Every Credit Offer
A final factor to be mindful of is how often you get your credit checked by applying for credit (inquiries). The credit bureaus allow for a maximum of 2 inquiries per year. Each additional one can ding your score by 5-10 points. Various inquiries in one day count as 1 inquiry because the bureaus understand you may be rate shopping. So if you want to compare rates, such as for a loan or credit card, apply everywhere on the same day.
When applying for credit, keep in mind that the information on your credit report today will be from last month. So don’t pay off your credit cards and expect your score to skyrocket the next day. It will happen at the end of the billing cycle when the banks and credit companies report your information to the bureaus. In fact, before doing so I recommend you check your own credit report to make sure there are no errors or anything suspicious like identity theft or fraud.
Monitor Your Own Credit for Free
Everyone can obtain their full credit report for free athttp://www.annualcreditreport.comonce per year from each of the 3 credit bureaus. If you spread it out, you can get your report up to three times per year for free. You don’t get a score this way as you need to pay for that, but you can see all the information that comprises your score, and if you need to dispute anything, you can easily do so online from the annualcreditreport.com platform.
The Bottom Line
In summary, building up good credit history takes time. Don’t believe any claims that say otherwise, like trying to sell you services to “buy” a good credit score or that guarantee to “clean up your credit.” Like a reputation, it’s based on your behavior and what you do over time. Making your payments on time and trying to not have everything maxed out when you get your credit checked are the key take-aways. Also, you can monitor your own credit for free up to 3x per year. I especially recommend doing so before you plan to make any big changes, get a new credit card or loan.
Do you have any questions about what impacts your credit score? The next article in this series will be answering frequently asked questions.
Do you have experience with credit scoring in other countries? Are the rules more or less the same? I’d love to hear your perspectives!