Your credit history is what lenders look at before deciding to fork over money to you. When lenders look up your credit history, they get your credit score – which is essentially an indicator of your creditworthiness.
What is a Credit Score?
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A credit score is a three-digit number, usually between 300 and 850, calculated based on information in your credit report. There are lot of components that go into it, including the number of type of credit accounts you have, the amount of credit available, how long you have used your credit accounts and payment histories.
When you use credit, you are borrowing money with the promise that you will pay it back with interest over a longer period of time. The better, or higher, your credit score the less interest you have to pay. In the long run, having a higher credit score will save you a ton.
On the flip side, a lower credit score will hit you harder financially.
What Your Score Means
Imagine you’re married and have a few kids. You want to buy your first house and are looking at a few options. You settle on a nice colonial style 3 bedroom house, the perfect place to raise a family. The price tag: $290,000.
If you want to see how your credit score can impact you financially just take a look at the following table. Take a look at how much you will end up paying on a $300,000 30-year mortgage.
|Credit Score||Annual Interest Rate (%)||Amount you will pay in 30 years|
The difference between the top credit score bracket and the lowest is more than $100,000!
It’s easy to see why having a poor credit score can be devastating to your finances. The good news is that no matter what your credit score is today, you can always take action to improve it.
First off, start by checking your score. Do you know what it is? It might be better than you think, and you won’t have to worry, but if it turns out you’ve been neglecting your finances then here are 3 ways you can improve it.
1. Set up an Automatic Payment System
About a third of your credit score is based on your payment history. It’s the single biggest factor in determining your score and being able to improve your payment history will go a long way towards improving your score. Setting your improvement efforts on auto pilot will also give you peace of mind.
Don’t wait until the end of the month rolls around and you are scrambling.
Did I pay off that car insurance bill?
Hold on, I thought I sent in my check to the electric company already…
Don’t be that person! This method will eventually fail you, and when it does you will get slapped with huge penalties.
Nowadays it’s a simple matter to set up automatic payments. Your telephone, utilities and rent payments can all be taken care, and all you have to do is review your bank account at your own leisure after the fact.
Try to pay off your entire credit card balance, but if that’s impossible then at least aim to pay the minimum on time all the time, every time.
2. Pay down your debt
Yup. There aren’t any amazing, quick fixes here. Improving your credit involves doing the hard yards and actually paying off your debts.
Figure out how much you owe. Put it down on paper and get it out of your head. It’s much more manageable that way.
There are numerous debt calculators online that you can use to figure out exactly how much you have to pay and how long it will take to pay off your debt entirely. Use them!
Once you know what that number is…attack the debt ruthlessly and automate your payments so you don’t have to think about it.
In 2012, a pair of Tennessee teachers added up their debts and found they owed $92,645. They paid it off in less than 3 years using Dave Ramsey’s Snowball Method – a technique that says people should pay off their smallest debt first, and use the emotional boost from that win to take on the next smallest debt, and so on and so on, until it is all gone.
Make no mistake, it won’t be easy. That Tenessee couple had to make hard sacrifices. Bryant and Emily Adler took on second jobs and forbade themselves from buying new clothes, but in the end it was worth it.
3. Set up an account with a small payment that you can reliably pay off every month
A monthly Netflix charge is a good example. By paying that $8.99 every month you are building a solid repayment record. The longer your history of good debt, the better it is for your credit score.
A small charge also makes sure that your credit utilization ratio is low, which is a good thing.
For example if you have a $500 credit limit, and the only charge you are making is your Netflix subscription, then you have a utilization rate of 8.99/500, or about 1.8%. The general rule of thumb is that you’re in good shape so long as you keep your utilization rate under 30%. Anything lower and you are golden!
If you have higher payments to make, and a low credit limit then your utilization rate will naturally be high. In that case, it might be a good idea to call your credit card service rep and ask for a higher limit. This, of course, depends on your payment history but increasing that limit (so long as you don’t increase the payments made) will lower your credit utilization ratio.
Figuring out how to raise your credit score is both simple and hard. The benefits are there to be had, you just have to want it badly enough. As the Adlers say, “There’s always hope. We know what it’s like to look at your finances and feel hopeless…but you can change your circumstances.”