What is Credit?
Credit is money lent to you by a lender or creditor on the conditions that you will pay it back at a later date. The terms and conditions for receiving the credit vary by credit type and lender.
Why Does Credit Matters?
Like it or not, credit is a necessary evil and your credit is the foundation in regards to every aspect of your financial life. Obtaining, sustaining or repairing less than perfect credit is one of the most important financial decisions you can make. It’s a decision that is either going to cost you money or save you money in the long run! Either way, that cost or savings is “significant”.
It’s important to understand that poor credit can hinder your ability to rent an apartment, purchase a vehicle, obtain a credit card, buy a house, qualify for insurance and much much more. Your credit and the rate of interest at which you borrow is determined by a number of factors; including your current financial obligations, monthly expense obligations, your credit history and FICO Scores.
What is Your FICO Score?
Your credit score or FICO score is a very important number in your life! The number has been designed to convey to lenders the kind of financial risk they would be taking by having you as a customer. Your score is generated by a credit analyzing software that takes into account the following questions:
Do you pay your bills on time? How much debt do you have? How long have you had your accounts? Have you ever defaulted on loan agreements in the past?
The process is complicated, however it does provide the lender a way to determine whether or not to lend you the money. FICO scores are calculated from different credit data in your credit report. This data can be grouped into five categories outlined below. The percentages in the chart reflects the importance of each FICO score.
These percentages are based on the importance of the five categories which consist of, Amount Owed, New Credit, Payment History, Credit Mix and Length of Credit History.
What is a good FICO® score?
Excellent = 800 and higher
With scores in this range your credit or loan applications should always be approved. In addition you should receive the lowest possible interest rates.
Very Good = 700-799
A great range to be in. You most likely will be approved for any type of credit or loan and you should be able to take advantage of good interest rates.
Good = 680-699
With scores in this range you should typically get approved and your interest rate will be in a reasonable range.
Fair = 620-679
Depending on the type of loan and your credit history, you may find the rates quoted are not the best, therefore costing you extra money in the long run. If you are approved, certain restrictions will apply.
With scores in this range the chances of approval are low. You will end up paying a whole lot more over a longer period of time.
Very poor = 500-579
If you are able to get a loan at all, your terms and interest rates will be through the roof costing you a ton of money in the long run.
Bad = 499 and lower
You need serious professional help with your credit situation. If you do not get your situation under control things will only get worse.
What are the Benefits of Good Credit?
A healthy credit score of 700 or above can help you qualify for low interest rates on home loans, car loans and credit cards. If you are considered to have a good or excellent credit rating then you will benefit in the following ways:
• Quick credit approval
• Lower interest rates
• Refinance current loans for lower interest rates
• Get better credit card, auto loan, and mortgage offers
• Better employment and promotion opportunities
• Better insurance rates
• Rental approval
• Reduced deposits for utilities
The Cost of Bad Credit?
As mentioned above, the average American with less than perfect credit spends an extra 30%-40% a month in higher interest rates. Don’t allow your less-than-perfect credit keep you from reaching your financial goals. You can always get help to restore your credit to good standing.
Furthermore, once you have obtained credit it is important that you do everything possible to keep your credit in good standing. Below are a few tips that will ensure good credit history.
Pay Your Bills on Time Each Month – The largest factor that lenders take into account when determining whether or not to extend your credit is your “payment history” this is based on your ability to make your payments on time each month. If possible pay more than the minimum amount.
Continue to Build Payment History – Depending on the lender and the type of credit or loan you are applying for, most lenders today want to see a minimum of 6-12 “consecutive” months of good payment history before they will even consider extending your credit. So ideally you will continue to make your monthly payments on time for at least 6 – 12 months. Understand that the longer you have an account in good standing with current monthly activity the better for your scores.
Keep your Balances Under 30% of your Credit Limit – Once you have charged more than 30% of your credit limit on any given credit card, your FICO scores will begin to be negatively impacted. The closer you get to maxing out a card, the bigger the hit to your credit scores. For example, if the credit limit on your card is $1,000 keep your balance under $300 monthly.
Do not Close Accounts – Many consumers make the mistake of closing out accounts thinking that this will help their scores, when in reality it may hurt you. The reason being, your FICO score takes into consideration something called a “credit utilization ratio”. This ratio basically looks at your total used credit in relation to your total available credit; the higher this ratio is, the more it can negatively impact your FICO score.
So, by closing an old or unused card, you are essentially wiping away some of your available credit and thereby increasing your credit utilization ratio which can have a negative impact on your scores.
Therefore with all the money you save, you can make progress on important financial goals such as saving for retirement, boosting your emergency fund or getting out of debt faster. That’s the real power of great credit scores.