by Danielle Arlotta CFP®, Lead Planner
In the first two editions of our special weekly newsletter, we talked about savings tips and how to manage spending without tracking expenses. Another pillar of financial literacy is understanding the basics of the US credit system. It can be a confusing thing to tackle if you don’t know where to start. Both your credit score and report are used by lenders to see your credit risk and determine the interest rate or if they want to lend money to you. There are three credit reporting agencies: Equifax, Experian, and Transunion. These agencies are where creditors pull your credit reports from.
Below are 5 things you should know about how credit works so that you have everything you need to raise your score:
- Your credit score and credit report are two different things
Your credit report is a summary of all of your debt and credit history. This generally covers any loans, credit cards, or collections accounts from bills that were past due like a utilities bill or even late fines from public libraries. Your report includes any delinquencies along with your current employment and if you’ve been sued or filed for bankruptcy.
Your credit score is a three-digit number (usually between 300-850) that shows your “creditworthiness.” If your credit score is higher, that usually means that you have used credit responsibly. You can check both your credit score and your credit report for free. Checking your credit report is important because you want to make sure that there aren’t any inaccuracies that may be hindering your ability to get credit.
- How your score is calculated matters
The first major factor in your score is your payment history, which is 35% of your score. The agencies are looking at on-time payments, consistency, and any delinquencies or collections. The next biggest factor is credit utilization, which should be under 30%. This means that you should only be using 30% of the revolving credit (credit cards, HELOC, personal lines of credit) available to you. The other three categories used to calculate your score are length of credit history (15%), new credit (10%), and mix of credit (10%).
- Applying for credit can affect your score
This applies to the “new credit” category. If you are applying for credit often it could negatively impact your score. You may have heard the terms “hard inquiries” and “soft inquiries” before. Hard inquiries negatively affect your score when you are actively applying for loans or credit. Some types of credit inquiries, also called “soft inquiries” do not impact your score, though they will appear on your credit report. Before you apply for a credit card or any type of loan, make sure the extra credit is worth it knowing that your credit score could be impacted for a period of time.
- Start building credit early
Since a major part of your credit score is based on your credit history, you want to start building your credit as soon as possible. You can do this in a few different ways. One way we recommend for people who have no credit history is a secured loan. Usually, these types of products are offered through a credit union. Another option is to become an authorized user on someone you trust’s credit card. Remember, do not close any of your credit cards unless they have an annual fee. Closing a card can also negatively impact your credit.
- Keep your revolving debt to a minimum
Revolving debt are things like credit cards, personal lines of credit, and home equity lines of credit. These are debts that you can continuously draw from dispensing on the limit and the payment is based on the amount you owe at that time. These are the accounts that are being considered when the credit agencies are looking at your credit utilization score, so the lower the balance on these types of accounts, the better!
Next steps:
- Check your credit report here. Right now you are able to pull a report from each bureau weekly. We recommend that you check it at least annually.