Getting Cool With Your Credit

In this post, we will introduce the often misunderstood measurement of your consumer-worthiness, the credit score. To help those at all levels of understanding, we will break down what needs to be known by addressing four simple questions.

1. What is a credit score?

2. Why does credit matter?

3. How do I establish and/or improve my credit?

4. How do I monitor and/or protect my credit?

What is a credit score?

In the simplest terms, a credit score is nothing more than a number representing how reliable you are at paying bills on time. This number is tracked and recorded by three credit reporting bureaus, TransUnion, Experian, and Equifax. You may have heard of the term “FICO Score” which grades consumer credit on a scale of 300 – 850, with 850 being the highest score possible and 300 being the lowest score possible.

Now that we understand what a credit score is, let’s talk about how it is determined. Some may think if they pay their bills on time, their credit score should be great. Although paying bills on time is a big factor in determining a credit score, there is more to it than is initially perceived.

• Ratio of outstanding credit to available credit limit

• Aim to be under 50%. If you have a credit card with a $10,000 limit, it is best to pay off the balance before it reaches $5,000 in a given month.

• Paying bills on time

• There is not much else to add here.

• Bankruptcies, foreclosures, liens

• These events do hurt your credit but they do not ruin your credit forever. The general rule is these marks only stay on your credit report for seven years. However, their impact on your score lessens each year over that time period. Nonetheless, it is best to avoid these if at all possible.

• Age of open credit

• The more credit history you have, the more information lenders have to assess your credit worthiness. If you are thinking about closing your first credit card because its limit is too low, think again. Consider paying off any remaining balance on the card then find a nice place for that card to collect some dust outside of your wallet.

• Total credit accounts

• Credit accounts include credit cards, mortgages, student loans, auto loans, etc. Having multiple lines of credit can be a good thing. However, your score can take a negative turn if there are too many open accounts with negative balances.

• Total credit inquiries

• When applying for a new loan or credit card, your credit gets checked. The more times your credit is checked by lenders, the more your credit may be negatively affected. A high frequency of inquiries might indicate to lenders you are desperate for credit. Note these inquiries do not affect credit scores as much as the factors mentioned above.

Why does credit matter?

By now we know a credit score is important in obtaining loans. A credit score not only determines your ability to borrow, but the cost of borrowing. In the eyes of lenders, the lower the credit score the higher the risk in a borrower defaulting on a loan. Therefore lenders want to be compensated for taking on that additional risk. This risk premium is paid by the borrower in the form of a higher interest rate on the loan.

Aside from the better-known impact on borrowing, a lower credit score can also affect your ability to be hired for jobs within certain industries such as Accounting, Finance, Business, and Insurance. Maybe a few late payments are harmless but let’s aim to never need to find out personally if that is or is not the case.

How do I establish and/or improve my credit?

Establishing credit is fairly simple and is best done so as early as possible, age 18. Starting early is a great way to ensure there is ample credit history in place by the time we take on some of early life’s major expenses (car, house, etc). Establishing credit early isn’t as easy as it used to be. Understandably so, the Feds require credit card owners to have either an income, if not then a co-signer. Assuming you have one of those two things, getting a card with a low limit of about $500 will be a simple process. Start small with gas purchases and pay off the balance each month and your future self will thank you tremendously when I comes time to buy that car or house.

As for improving existing credit, the most impactful step is paying your bills on time. For those of us who graduated college with student debt, loan consolidation is critical in reducing the amount of open credit accounts with negative balances. Also, try to stay away from store credit cards and focus your spending on a single card when possible to make monthly payments easier to manage. Above all, only make purchases on credit if you have the cash on hand to pay it back. Credit cards should be for convenience and in some cases rewards, not to buy what we are unable to afford.

How do I monitor and/or protect my credit?

Monitoring credit can be difficult on your own but please be careful in being tempted to pay for credit monitoring services. There are many options out there today offering free credit scores, making it more practical to monitor your own credit. The exact credit score shown on sites of Credit Karma may not be the exact same as your FICO score from the three credit reporting bureaus, but the idea is to monitor your score for any unexpected downward movement.

Another way to monitor your credit is to request a copy of your full credit report from the three credit reporting bureaus at annualcreditreport.com. Consumers are entitled to one free full credit report per year without an inquiry being marked on their credit score. The main area to pay attention to is the “open accounts” section which will display all loans and lines of credit. If you suspect one of the accounts listed was opened fraudulently, call the institution at which the account is held to remedy the situation or get your financial professional involved.

Freezing your credit is another way to protect yourself from fraudulent activity. This involves calling each of the three credit reporting bureaus separately to put a “freeze” on your credit which will block any and all inquiries on your credit, thereby stopping any potential fraudulent activity in its tracks. If you encounter a situation where you need to open a legitimate line of credit, you will need to call each of the credit reporting bureaus to “un-freeze” your credit. Once that line of credit is successfully opened, you will need to call again to “re-freeze” your credit. Bear in mind there is a cost each time you freeze and un-freeze your accounts which vary by the three companies.

Always Remember

Credit is important but try not to become too wrapped up in the number. Do the right things every day and the number will take care of itself and more importantly it will take care of you. Credit does not need to be perfect, just good enough. A score of 740+ essentially gets you just as far someone with a score of 800. The only real difference is that the holder of the 800+ score is more likely bring up the conversation about credit in the first place!

The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Securities offered through Securities America, Inc., member FINRA/SIPC, Betsy Merritt & Tyler Aubrey Representatives. Advisory services offered through Securities America Advisors, Inc. New Break Financial and Securities America are separate companies. Securities America and its representatives do not provide tax or legal advice. It is important to coordinate with your tax or legal advisor regarding your specific situation. Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes. Neither asset allocation nor diversification guarantee against market loss or greater or more consistent returns.