Understanding and Repairing our Credit Score

It used to be that our credit score only mattered when we wanted to borrow money, but in recent years, more aspects of our lives are starting to be affected by our credit score, including insurance rates, renting an apartment, even getting a job.  Today we want to talk about how we can better understand our credit score and what we can do to repair it if it’s not where we want it to be.

The following recording is from “Mornings with Kelli and Steve” on Moody Radio Indiana (97.9 FM).  For more information on Moody Radio, go to moodyradio.org/indiana.

The logical place to start this discussion is with an explanation of what a credit score even is.

Credit scores (also known as a FICO score) are simply a number that indicates how credit-worthy you are.  Those numbers range from 300 on the bottom to 850 on the top.  The higher the number, the more credit-worthy you are.  Lenders will look at that number to determine whether or not they want to loan you money.  The lower your number, the more difficult it will be to borrow money and it will also be more costly.

What are the factors used to calculate our credit score?

There are 5 factors used to come up with our credit score.  I’ll go in order of the biggest contributors down to the least.

• Payment History on past debt (accounts for 35% of most scores)

• Do we have late or missed payments in our history? If so, those are going to hurt our credit scores.

• Credit Utilization – percentage of available credit being used (accounts for 30% of most scores)

• If we’re using most or all of our available credit, we’re considered a higher risk, so it’s good to not have all our credit accounts maxed out.

• Length of Credit History (accounts for 15% of most scores)

• The longer we’ve been using debt, the more history they have to evaluate us. If we have a short credit history, there’s not much evidence of us being a good borrower.

• Mix of Accounts (accounts for 10% of most scores)

• While not a big factor in our score, the type of debts we have matters. Is it credit card, retail, installment or mortgage debt?

• New Credit Inquiries (accounts for 10% of most scores)

• Opening new credit accounts in a short span of time or having too many pulls on your credit can hurt your credit score. It makes you look like you’re a bigger risk.

Once we have an understanding of the factors used to generate our credit score, where should we start in trying to improve our credit score?

• Start by looking at the information being used by the credit bureaus to make sure it’s all accurate. You can run one free credit report each year from each of the 3 credit bureaus.  Go to annualcreditreport.com to request it.  If you run the first one and it all looks good, you may be fine not looking at the others right away.  If you find an error, dispute it right away to try to get it corrected.

So, we’ve reviewed our credit report and everything is accurate.  What are some other things we can do in our daily living in order to improve our score?

It all goes back to the factors used in calculating our scores.

• Pay all your bills on time. Even if you have a bad history, you can build a new one over time.  Commit to keeping your bills current going forward.
• Pay off existing debt. This will decrease your utilization rate.  If you have accounts with small balances, pay them off because a lot of small balances can hurt your score.  If you use credit cards for ongoing expenses, try to use just one or two instead of many.
• While you’re trying to build your credit score, don’t close your older accounts as you pay them off because you want a longer credit history.

What about the younger person that doesn’t have a credit history, what should they do to start building their score from scratch?

Building a credit score is somewhat of a pay to play process.

• The easy place to start is by signing up for a credit card, using it for a few expenses and then paying it off each month. You want it to be from one of the reputable credit card companies and not have an annual fee.  If you’re trying to help out a son or daughter, you might want to have the credit card statement come to your home so you can help keep them from misusing it and make sure it’s paid off each month.
• Next, you may want to look for another type of loan for your history. The easiest is a car loan.  If your son or daughter is buying a car, you may want to have them borrow a small amount for the purchase even if they have the cash to pay the full price.  They’ll be paying a little extra in interest each month, but they’ll be building their credit history in the process.  This is that pay to play scenario I mentioned.  While we don’t like debt, we can use it in a smart way while still protecting ourselves and our loved ones.

Brad Graber, CFP® has been working with clients on personal financial planning and investment issues since 1996. He invests his time mentoring and educating individuals on ways to be better stewards of the resources God has entrusted to them.