Your credit score

What is a credit score? A credit score is a three-digit code that is generated by the three credit bureaus: Experian, TransUnion and Equifax. Lots of companies use that score to make decisions about you. Many also take the information provided by the credit bureaus and use it to create a code with their unique criteria and weighting. Whether you’re buying auto insurance, renting an apartment or applying for a credit card, there’s a good chance that one or all of the bureaus will be contacted and asked to provide your credit score or credit history. That’s because businesses believe, rightly or wrongly, that people with good credit are more reliable. If your friend, Debbie, asked you to lend her $50, wouldn’t you want to know how likely she is to pay you back? You might ask Sarah, who lent Debbie $50 last month, whether or not she’d been paid back and how quickly. If you apply for a mortgage, the lender wants to know how likely it is that you’ll pay back the money. Past history can help calculate the odds.

What’s your credit score? If you’re telling me that you don’t know, I’m telling you that you need to find out. If you want to create wealth, you need to be intentional about your finances and that starts with a great credit score. So right now, go to annualcreditreport.com and request your report from each of the three credit bureaus. Look at every single item on the report. Make sure it’s really yours. If it’s yours, make sure it’s accurate. If it’s not yours or it’s yours but not accurate, contact the bureau and let them know. There is a button to dispute the item. Do that.

Now let’s look at the items that are yours and are accurate. Is everything current? If not, you must get them current. If necessary, contact the debtor and find out what you can do to negotiate some type of settlement or pay-off or a payment plan that you can maintain. No one new is going to want to loan you money if you can’t manage the debt that you have and lenders are not glass-half-full kinds of people. They really focus on the bad stuff.

Once everything is current, is there anything on your report that is showing as a negative? If possible, write a letter explaining why this happened. Send a copy of the letter to whichever bureaus are showing the item. The letter will be sent to anyone who requests your credit report. It’s not perfect but it does show that you’re on the right track and being intentional about improving.

We say that coming up with your actual credit score happens inside a black box meaning that no average person knows exactly how it’s calculated and what weight is given to the various components. This is true but there are some important factors:

Available Debt

How much available debt do you have? Your available debt is the amount that you would owe if you maxed out every one of your credit cards and credit lines. To a lender, this is the worst possible scenario. To calculate this, add up the credit lines for all of your credit cards and the original balance for any loans that you have outstanding.

For example: let’s say that you have three credit cards and a car payment. You add up the credit lines of your three credit cards and the amount that you initially borrowed for your car loan and figure out that you have $40,000 in available debt, two credit cards with a $7,500 credit line, one card with a $5,000 credit line and $20,000 was the original balance on your car loan: $7,500 + $7,500 + $5,000 + $20,000 = $40,000.

Credit Utilization

How much of your available debt is actually available? To calculate this, add up the current outstanding balance on the credit cards and the car loan. Now divide the total of the outstanding balances by your total available debt. For example, if you owe a total of $7,500 on the credit cards and $10,000 on your car that would mean that you owe $17,500 and are using .4375 or 43.75% of your available credit: $7,500 + $10,000 = $17,500/$40,000 = .4375. This is good because lenders like to see that number as low as possible and definitely under 50%.

How about usage by source? You owe $7,500 on your credit cards. Is that $7,500 all on one card with a $7,500 balance or is it spread equally between the cards? In general, your credit score will be higher if the balance is spread equally over the cards. In other words, it’s better to owe $2,500 on three cards than $7,500 on one card. The good news is that you can transfer that balance and see a quick impact on your credit score. If you only have one card, contact the company and see if they’ll increase your credit line. If you could get that $7,500 limit up to $15,000, it not only lowers your percent on that card, it lowers your percentage overall. Now you’d only be using 37% of your available debt.

Credit Inquiries

How many credit inquiries? My boyfriend is a bargain hunter. Every time we go shopping and the store offers him a coupon or discount for opening a credit card, he says yes. When he ran his credit, he was surprised that it was so low. He has a lot of available credit and pays his cards off every month but his score was much lower than it had been a year earlier. Why? Each time he applied for a credit card, the store would run his credit. To the computers that calculate your credit score, this looks like you’re having financial trouble and are trying desperately to get more available credit. This goes into the bad column and can hurt your score. Be discriminating when you apply for additional credit and try to limit it to three times or less per year. If you’re hoping to get a mortgage soon, don’t apply for any more credit cards, don’t buy a new vehicle, nothing. Lock down your credit and don’t unlock it until the lender requests it.

Age of Credit

How old is your oldest credit line? Things can go wrong when you have a credit card and there are lots of reasons why you might want to close your account. Be careful, though, when you decide to do this. For one thing, it will reduce your available credit so your percentage of credit used will go up, see Credit Utilization above. You could also close an account that you’ve had for a long time and that can hurt your score. The credit bureaus like to see that you can maintain a long-term relationship – with your credit companies at least.

Many credit card websites offer score calculators that will simulate what happens if you make specific types of changes. For example: let’s say you want to take out a new $20,000 credit line. The simulator will tell you what impact that will have on your credit score. You can experiment with various options there or use a site like nerdwallet.com.  Here’s more info on how your score is calculated.

Make a decision today to be intentional about your credit score. That simple act will have a huge impact on your financial future.

Next week:  HBU E05 Cyberstalk Your Dream House

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