The paradox of the Credit score: to get a high credit score, you must first accrue debt.
Wait, how does that work?
It’s true! Getting a high score is only achieved through consistent payments on existing debt, but often times to get debt, you have to have a high score. Luckily, Fiscal Tiger is here to help you understand the nuances of the credit score.
Are you struggling to find banks that will give you loans or credit cards? How does credit score work, and what aspects of your life are affecting it? Here is some advice to help you understand your score, and how to help it improve.
The Math Behind the Score
Your have three credit cards, a student loan, a mortgage, and your credit score is somewhere near 550. Your financial advisor says you need to improve your score to secure a new loan, but what is that supposed to mean? Isn’t 550 a high number?
Well, credit scores are broken down into five categories that affect it differently. The score’s number ranges from 300-850, and the higher the better. When you start, it sits at 250, and you have to build it up from there. FICO has a nice break down of what all affects your credit score1:
- 35 percent of your score is based on your payment history
- 30 percent is based on current debts
- 15 percent is determined by credit history
- 10 percent is allotted to new credit applications
- 10 percent is about types of current credit
Credit scores are determined in a couple of ways.
First, your credit history will determine your report among credit bureaus. Then your report will analyze credit risk based on the five standards mentioned above. Those reporting agencies (or credit bureaus) are Equifax, Experian, and TransUnion. Each of these companies will have their own credit score for you based on your history.
FICO (Fair, Isaac, and Company) is a company that will evaluate your score with these three credit bureaus and will – through predictive analytics – determine your credit rating for banks. The FICO score is one of the most widely used scores among banks that will determine your credit standing.
All in all, your credit score between FICO, Equifax, Experian, and TransUnion will not be very different. They are all determined by the same data and based on your credit history.
Ways You are Hurting Your Score
There are a number of reasons why your score might be low. If you’re brand new to the credit game, and you have never opened up a line of credit or loan before, it will always be low. If you have a history of not paying your debts on time, and have a history of late payments on credit cards or loans, it will slowly lower your score. If you have opened and closed multiple credit card accounts, it will be low. And, if you have high interest rates and high debts on your credit card or loan accounts, it will be low.
However, there are certain aspects that might reflect positively but might seem like a negative. An example of this is through the types of debt you have. The more debt you have, as in the variety of debt (mortgage, card, and loans) the better your score. Credit Bureaus care more about your regular payments than about how much you owe. (EXCEPT when your credit card or loan is maxed out. This will hurt your score.)
Credit Bureaus do want to see a variety, though, and so opening different types of loans can often help you increase your score. Opening multiple credit cards, however, will hurt it.
A Forbes article from 2016 breaks down the basics of how many credit cards you should have and why: “There’s no golden rule for how many credit cards you should have. The “right” number depends on your spending behaviors, financial goals and how responsibly you manage your credit. The more cards you have, the more diligent you’ll have to be in tracking your credit activity.” Basically, don’t have more cards than you can manage, and avoid racking up massive amounts of debt2. If you have multiple cards, make sure to keep their amounts low, and make regular payments. Also, opening up multiple lines of credit in one year can look “sketchy” to the big three Bureaus, so avoid doing it all at once.
There are also some more obscure ways you can negatively affect your score. This includes everything from late rent payments, to medical bills, and even library fines in some cities3 can be sent to collection agencies if you don’t pay them. Once that happens, the credit bureau is sure to find out, as they get reports from collection agencies. Your score will start to drop dramatically unless you pay up or dispute the claim within 30 days of the initial call4.
Also, be wary of regularly checking your credit score. Having more than two “hard checks” a year can knock down your score over time, as the credit bureaus will assume you’re doing it to open new lines of credit5. Hard checks only occur when credit lenders are asking for your score. Getting a new cellphone or having your rental agency check your credit is known as a “soft check” and does not hurt your credit score.
Additional Ways to Improve Your Score
If your score is low and needs some improvement, look into refinancing some of your loans, or finding ways to cut back on your spending so you can more accurately tackle those debts. Lifestyle choices tend to be a common problem among those with a low score and a lot of stacked up debt.
When you close accounts (such as for utilities and gym memberships, but not credit card accounts) make sure you’re doing everything properly, and triple check with the company that it was closed completely.
Also, look into opening a secure credit card if your credit is really low. The secured card works more like a loan on your own money, but gives you the opportunity to show the banks that you can make payments on time. Over time, your score will gradually improve.
Finally, if you have too much debt, and it’s impossible to manage it, consider filing for bankruptcy. It’s a useful way to wipe your debts clean and start fresh. It does come with its own problems, though, so make sure you’re checking every avenue before you file.
The credit score paradox doesn’t need to keep you puzzled. Once you understand the nuances of your score, you should have a better handle on how to improve it.
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