Borrowing Money and Your Credit Score

Photo credit to Crosswalk.com

Borrowing Money and Your Credit Score

Do you want to borrow money?  Maybe borrowed cash would help you with your business, school tuition, to buy a house, to buy a rental property, for a line of credit or to buy equipment — some of the things that could help your life to be more productive.  This is when it matters — when you have a need to borrow money, and that’s when that crazy thing called a Credit Score intersects with your life. 

If you’ve paid your bills late or defaulted on a loan, you know that your credit rating gets dinged.  This may not matter to you if you have no need to borrow money.  If you pay cash, use a debit card and aren’t in the market to buy a piece of real estate, years may go by when your credit report has no bearing on you.

Then, one day, you imagine a line of credit to pay some schooling expense, or such, and lo and behold, you might wish that you had paid attention to this fictitious number all along.  The good news is that ‘women outpace men in the median credit score’, says Experian for this year.

This article will include ways to get your credit score for free and ways to improve your score to make up for any hiccups. 

Your credit score is otherwise known as your FICO score because it was developed by FICO, a company that specializes in what’s known as “predictive analytics,” which means they take information and analyzes it to predict what’s likely to happen.

Your credit score is just a number — a number that summarizes your credit risk, predicting your behavior with debt.  It’s arbitrary in many ways.  The formula for how your credit score is calculated is some deep dark secret of its creators, but over time what the calculation is based upon has been ferreted out by some smart people. 

This will be of interest to you, to know how to improve your credit score, what you can do to look better to lenders, and how you can think ahead with your FICO score to be in the best position.  Keeping and having good credit will keep your options open.  And if your score is down these days, no worries, you can improve it!

Your credit score is a number that says if you are creditworthy.  While you may think you are worthy if your score is below 650 points, you may get the loan but you may be paying higher interest.  And, here’s the catch.  On a $150,000 fixed rate 30 year mortgage if your credit score is 720, you’ll pay substantially less over the course of the entire loan than someone with a 550 point credit score.  Since your payments are $459 less per month, because you have a better interest rate, this will be a savings of $165,000 over the life of the loan with better credit — big fat difference!

The best credit score wins.  And, while you are so much more than your credit score, it’s a good idea to position yourself carefully.

Your credit score contains basic information about you, and your history in relation to debt — your debt, your credit cards, installment loans, car loans, department store accounts, collection agencies, foreclosures, bankruptcies, IRS liens and money judgments, it’s all considered. 

Your credit score can range from 300 on the rock bottom to 850 on the top.  Generally, 650 points and above is considered good credit, and anything below that is a chance to rally up some improvement.  Each person has their own credit score.  So, in a married couple, he has his own score and she has her own score — there is no combined credit score. 

You do a credit check-up, just like you do a health checkup.  You assess the general condition and the need for improvement.  You can get a copy of your report for free by going to www.FreeCreditReport.com, and the score for free by going to www.CreditKarma.com.

Your FICO score is reported by primarily three credit agencies which are TransUnion, Equifax, and Experian.  Your scores will probably vary from one company to the next.  Credit companies do make mistakes, lots of them, and there are probably many (more than you think) people with your same name.  That’s why you have to check all of the credit reports carefully and see that things haven’t been reported on your account that doesn’t belong to you. 

Income does not affect your credit score, nor does wealth in your investment account.  This number is simply a result of how you have handled debt in your life, on a transactional basis.  The credit companies do look at your employment status.  And know that if you’re between jobs and you want to keep your credit shiny, that you can call them up and tell them that you’ll be unemployed for some period of time.  This will soften any blow on your credit. 

Women Discussing about the Credit Score

Photo credit to Kiplinger

Here are the factors that they do consider when calculating your FICO credit score:

  1. 35% of your score is ‘Do you pay your bills on time?’  This is a biggy!, which is why it all loops together and the importance of living within your means.  What’s more important to ‘will you pay them back’, than ‘did you pay someone back previously’? It begs the question. 

2.  30% of your score is “How much do you owe?’  Oddly enough, even though you   

     have a credit limit of $10,000, you get dinged on your credit score if you use all of

     your limit and don’t pay it off each month.  The theory is that if you are maxed out on 

     your credit capacity, that you are more likely to be a credit risk.  It’s because you 

     have lived outside your means and are not demonstrating the means to repay the

     debt. 

     The ideal point is to only use 30% of your debt capacity without coming back to zero

     — in other words, maintaining balances that are only 30% of your approved credit.  I

     know it seems crazy but this will set you up for your best credit score.

3.  15% of your score is ‘How long is your credit history’.  If you’ve demonstrated over a

     longer period of time that you have managed your debt, then you are viewed more    

     favorably than if you have a shorter credit history. 

     This is why it’s really important that you don’t close any credit cards.  Again, this

     sounds paradoxical, but when you close a credit card you remove the history and   

     this can ding your credit score. 

4.  10% of your score is ‘Are you taking on more debt?’  The credit score tribe is looking

      to see if you are adding new sources of debt, in other words, looking to get further

      into debt.  This includes credit checks, maybe multiple ones if you’re shopping for a

      new car.  It’s best to do all of the shopping in less than 30 days because then it will

      be one inquiry and you won’t be seen as shopping for debt.

5.  10% of your score is ‘What mix of debt do you have?’  This includes a variety of debt

      like a credit card, a car loan, a mortgage and an installment loan — instead of all of 

      your debt being in consumer credit cards. 

With these guidelines, you can raise your credit score.  For instance, you get bonus points if you pay a credit card down to zero.  Again, you don’t want to close the credit card because that would wipe off the credit history, but if you pay it down to zero that’s in the good.  This can be contrary to financial advice which is to pay down or pay off your highest interest card first.  In this case, it may be your lowest interest rate card, but if it has the smallest balance it will help you with your credit score to pay it off.

Note:  you don’t get bonus points if you pay an installment loan down faster.  Just the way it works.

Also, income does not affect your credit score.  If you increase your cashflow, it’s all in the good, but it is your credit history that determines your FICO score.  Increased cashflow can help you in the future if you use it to reduce what shows as your debt. 

The credit score companies do look at your employment status.  That’s why it makes a difference if you are unemployed.  And, if you are self employed, it’s a good plan to communicate with the credit score companies to show that your company pays you a salary. 

The first thing to do is to get a copy of your credit report, look at it closely and see if there is any negative information on the report.  Does the report have something on it that is tagged to your name, but it’s actually for another person that has the same name that you do — this happens.  And opps, it could cost you more interest if it’s left unchecked.

Another way to protect your personal credit is to establish credit with your business.  Then what you do will reflect on the business and not be reported to your personal credit score.  This used to be easier, and the big banks such as Bank of America and Wells Fargo, are more reluctant to issue business credit cards these days.  However, the small community banks and credit unions are still able to do this for you.  Check out your local bank and credit union if you own a business.

Here are a couple of sticky points to be aware of.  If you are struggling with debt and are wondering about Consumer Credit Counseling, just know several things:  that this can be a long process, that it can have fees as high as 10% for this service, and importantly, this path of service may also be considerate in the calculation of your FICO score in the same manner as a bankruptcy. 

And here’s another important factor.  When you are married, your spouse can affect your credit score by his actions.  And, if you get divorced, you are not free and clear until your name is removed from all debts that you incurred as a couple.  For instance, if your name is on a credit card or a mortgage, or an installment loan, and he doesn’t make the payment for some reason, this will put a ding on your credit report.  Best to make sure that your name is clear of debts with any other person who can potentially upset your FICO score. 

The best path is to pay your bills on time and plan to live free of debt, particularly credit card debt.  This way you’ll be arranging to live your life on a cash basis, and chose to spend when you have cash in your checking account; or you develop a plan to earn the money that you want to spend for your favorite new TV, handbag or trip to the salon.  Credit cards were never meant to go shoe shopping with — they are meant for emergencies (real ones, not a shoe emergency) — in our lives as a temporary backup resource. 

Cash is not what’s left on your credit card.  Cash is your legitimate means of living in the context of your life, and increasing your cashflow will bring out and use the fullness of skills, tools and talents that you have to creating value in the lives of others.  If you live this way, you’ll be on the road to a really great credit score with the option and possibility of only using debt in ways that will grow your life.  Cheers!!

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