Miss part 1 of our Financial Literacy Month Series? Check out “Fix Your Broken Budget.”
You’ve probably heard both sides of the credit debate. Some say you should take full advantage of it while others tell you to stay far away from it. Who do you listen to?
If you ask us, credit is a tool that can be your best friend or your worst nightmare depending on how you use it. Would you want to put a chainsaw in the hands of someone who has no idea how to use it or someone who’s knowledgeable? The same is true for credit.
So buckle your seatbelt because we’re about to give you a crash course of what credit is all about.
What is credit?
Without getting into the dictionary definitions, credit is simply where you buy something of value now and promise to pay it back at a later date. Car loans, home mortgages, student loans, and credit cards are all types of consumer credit. You couldn’t afford to pay for these out of pocket, so you’re getting money for it now with the lender trusting you to pay it back later.
When you buy on credit, you will usually be charged interest on the money they lend you in exchange for giving you the funds. This gives you the chance to pay it back over an extended period of time.
Different types of credit comes with varying interest rates. Credit like federally guaranteed student loans have lower interest rates while credit cards have higher rates. Why? These student loans are guaranteed by the government and the lender will get the money back even if the borrower doesn’t pay. On the other hand, the credit card lender runs the risk of not get repaid. Hence the higher rate.
Credit reports and scores
Having some kind of established credit can help you when you eventually need a loan to buy a new car or house. There are three big credit agencies that keep tabs on you and how you use credit—from the amount you borrow to how timely you are on your payments. This is reflected in your credit report.
Not to be confused with your credit score, your credit report shows what you do with your credit, the state where you applied, whom you borrowed from, and whom you still owe. Now here is where the credit score comes into play.
Your credit score is determined by the information in your credit report. Your credit score is used by lenders to see how much of a risk you are when it comes to repayment. It decides if you qualify for a loan and what the interest rate will be.
What’s a good credit score? We’re glad you asked. Credit scores range from 300 to 850. Here’s how they line up:
- 300-579: Very poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very good
- 800-850: Exceptional
Just so you know, each credit agency is required by law to give you a free credit report each year. You can request it from AnnualCreditReport.com with no strings attached. We would recommend staggering your three requests throughout the year so you can stay up to date on your credit score.
If you need a little help understanding your credit report, GreenPath offers a free credit report review where you can sit down and review your report with a GreenPath credit report expert.
What is your credit score based on?
Now that you know what your credit score is and why it’s important, let’s talk about what determines your credit score. There are 5 different areas that make up your credit score with each carrying a different weight.
- Payment History (35%) — This is the most important because it shows whether you can, or can’t, be trusted to repay money that is lent to you. Have you paid your bills on time? If you’ve been late, how late were you? Have any of your accounts gone to collections?
- Amounts Owed (30%) — Your score is affected by how much of your total credit you use and the different types of credit in your report. Believe it or not, owing a little is better than owing none because lenders want to see if you’re financially stable enough to pay it back.
- Length of Credit History (15%) — How long have you been using credit? A long history is helpful as long as it isn’t blemished by late payments. If you’re just getting started, don’t worry because a shorter history is fine as long as you pay on time and don’t owe too much.
- New Credit (10%) — Your score considers how many accounts you have and how many new accounts you’ve applied for. If you’ve opened several new accounts, lenders see that as a risk and assume you will be making a lot of purchases on credit.
- Types of Credit In Use (10%) — The final aspect of your score looks at the different types of credit you have on your account. These can be credit cards, store accounts, mortgages, etc. This is a small piece of the pie so don’t worry if you don’t have multiple types of credit.
How can you improve your credit?
Let’s say your credit history is less than satisfactory. Can you fix it? Of course you can, but it will take some time, patience, and habit changes to get it done.
First, take a look at your credit reports and see if there is any incorrect information that could be causing your credit score to go down. All too often incorrect addresses and other personal information affects people’s score when it shouldn’t.
Next you should see what areas need fixing. Start by focusing on past due accounts and pay down your balance. It’s not the easiest, but it is a great way to improve your credit standing.
Finally, get some good credit history in your report. Look to open one, at the most two, new accounts and devote yourself to paying them off in a timely manner to start raising your score. Even go as far as setting up payment reminders so you’re not at risk for missing any payments.
Is your brain overflowing with credit knowledge? Always know that we are here to help you if you ever have any questions!