A low credit score can cost you a lot of money.
For Women & Co. by Nancy Miller, Wall Street Social - 03/04/2013
Your credit report is like a personal, financial report card. Get great grades, and doors can open to a world of financial advantages—lower mortgage rates, better deals on credit cards, and, increasingly, even better jobs or a nicer home. Moreover, by paying lower interest rates over time, you might be able to save thousands of dollars by investing the money in a retirement account or education fund.
Your credit score is a number or grade that reflects the information in your credit report. “The better your score, the lower the interest rate can be on your debt, which can lower your payment or shorten the life of the loan, and increase your opportunity to save,” says Cindi Turoski, a wealth advisor in Albany, N.Y.
Every time you use a credit card or apply for a loan, the great credit monitor in the sky is taking note, assessing the most important question of all: How likely are you to repay your debt? FICO scores have become synonymous with credit scores, but there are competitors, like VantageScore, also giving you As, Bs, or worse for the way you handle money. Prospective employers can’t actually access your credit score, but with your permission they can get a copy of your credit report and discover if you’ve ever been in bankruptcy or if there are outstanding liens against you, says Michele Pearson, Vice President of Consumer Information at Experian. That information is a critical part of your score.
FICO grades on a scale of 300 to 850. A low credit score can cost you a lot of money. According to myFico, consumers with a score above 720 who apply for a three-year $25,000 auto loan can get an annual percentage rate of 3.447%. Monthly cost: $732. For consumers with just so-so credit, say in the 620-659 range, the APR triples to 10.401%, or $811/month. Over the course of the loan, the difference adds up to $2,844. On a 30-year $300,000 mortgage loan, the gap is even more striking. Top credit borrowers pay just 3.104%, or $1,282/month versus 4.693% for lower quality borrowers, or $1,555/month. I calculated the lifetime cost, multiplying the difference in payments by the number of payment periods: $81,360.
Aspiring to be an “A” student in the world of credit? Here are the basics:
1. Be religious about paying your bills.
“Pay all of your bills on time. Every time,” says Anthony A. Sprauve, spokesman for myFico. Payment history usually accounts for approximately 35% of the FICO score.
2. Limit balances to 10% to 20% of the total amount of credit available to you.
That means you shouldn’t close out accounts you don’t use, says Turoski. “Sometimes people make mistakes and close out credit cards. But it reduces the denominator (of available credit) and can actually hurt that score.” Credit utilization (or outstanding debt) usually accounts for approximately 30% of your FICO score.
3. Establish credit early.
If you manage your debt well, the longer you have a track record, the better. Length of credit usually accounts for approximately 15% of the score.
A low credit score can cost you a lot of money.
4. Don’t open credit card accounts impulsively.
When you’re at the cash register, think twice before signing up for a new store credit card just because you’ll get a 20% discount on the purchase. “Those department store credit cards typically have higher rates. If you don’t pay the balance right away, you’ll wipe out the 20% saving,” says Sprauve. Credit companies don’t like when consumers apply for new credit frequently—they tend to be riskier clients, especially if they haven’t been handling credit for very long. How you manage new accounts usually claims approximately 10% of your FICO score.
5. Check your credit report every four months.
The major agencies—Experian, Transunion, and Equifax—must each give you one free report annually. On the other hand, myFico and creditreports.com each offer fee-based services to help you monitor your credit. CreditKarma.com calculates your FICO, VantageScore, and auto insurance score gratis.
6. Mix it up.
FICO examines the kinds of debt you have. Is it all credit cards or do you also have installment loans that you have successfully managed? Types of credit usually account for approximately 10% of the score.
7. Get out of debt.
The average indebted household carried $15,422 of credit card debt as of November 2012. If your debts are piling up, make a plan to pay them off as soon as possible. There are different methods for eliminating credit card debt, so choose the one that makes you comfortable. For example, you might start with paying off the smallest balance first because it builds your confidence. Or, you may prefer tackling the highest-interest balance first. For even more insight, read “4 Tips to Help Trim Credit Card Debt.”
The good news? If you work steadily over time to improve your credit score, the negative stuff will eventually disappear. You don’t have to live with a low score forever.