The Keys of Credit
Episode #3 of the course Personal financial literacy: Take control of your future by Riley Burger
Now that we’ve identified the wealth-building stages and learned a bit about setting up good savings habits, we can dive into credit. Credit is “a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at a later date” (Investopedia). When you apply for a loan, open a credit card, or open a store card at your favorite shop, you are acquiring a credit instrument.
Using credit can open a world of possibilities! A strong credit score can lower your rates on loans you take out, signal your financial responsibility to landlords and realtors, and allow you to make large purchases and pay them back over time.
That being said, credit can also be a slippery slope. Using too much credit without making timely payments can lead to a low credit score, a lack of faith from lenders and banks, and higher rates on loans. That is why it is critical to practice healthy habits.
The FAQs of Credit
What is a credit score? What is a good credit score?
A credit score is a number between 0 and 850 that signals your creditworthiness. While anything over 650 is generally considered a fine score, a score over 700 will help your chances of getting low-interest rates on loans, and proving your financial aptitude to a lender, landlord, or realtor.
How can I check my credit score?
There are three main companies in the US that give credit reports, Experian, TransUnion, and Equifax. You can get your credit score once per year from each reporting agency for free—this is called a hard inquiry. It’s good to monitor all three scores, as each company may have collected different data. It will also help you spot identity theft or mistakes on your credit report early. Note that making more than one hard inquiry per year may negatively affect your score.
To monitor your score more regularly, use a soft inquiry. This can often be done through your primary bank’s online site or mobile app and has no effect on your score.
What factors impact my credit score?
1. Payment history: Whether you consistently pay your credit lines down.
2. Credit utilization: Calculated by dividing the total revolving credit you are currently using by the total of all your revolving credit limits. The sweet spot is 30% usage.
3. Credit history length: The age of your oldest credit account, the age of your newest credit account, and the average age of all your accounts all factor into this one. Longer is better.
4. Credit mix: Just like you should diversify your assets (more on this later!), you should diversify your credit accounts. For this, having a mix of loans and credit cards (as long as you consistently make payments on them) makes all the difference.
5. New credit: This is where the number of hard inquiries on your credit score by lenders and recently opened credit accounts comes in. Less of each is better.
Loan Best Practices
When applying for loans (student loans, auto loans, mortgages, etc.), do the math: make sure you understand the responsibility of paying your loan back on time.
Before signing on to any loan, I recommend making an excel sheet that lays out every monthly payment of the loan, starting the day you get the loan and ending once your loan balance is zero. Make sure you are comfortable hitting each monthly payment considering your current monthly income and expenses. This is super easy to do once you do the budget exercise from Lesson 2!
Here’s an example:
Note: If there is an interest rate on your loan, make sure to factor that into the monthly payments. An interest rate makes it even more important to make payments on time. Feel free to try this great loan calculator from Credit Karma as well!
In the next lesson, we’ll continue learning about credit, and dive into wealth-building stage-specific guidelines for healthy habits!
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