What is a Credit Score?

Let’s start with the basics. Credit scores are the quintessential measure of financial health. It tells lenders how financially responsible you are; with modern day Americans so dependent on loans to fund their lifestyles of houses, cars or businesses alike, a credit score is just as important as how much money you have in the bank. However, similar to sensitive matters like politics or religion, it’s a topic that’s avoided because it can be too personal, provokes self-consciousness, and raises an opportunity for comparison. Fortunately, we’ll dive into this topic and hopefully set you on the right track going forward. 

Why is Credit Score Important?

A 3 digit credit score, usually ranging from the low of 350 to maximum of 850, reflects your creditworthiness. Generally credit scores from 580 to 669 are considered fair; 670 to 739 are considered good; 740 to 799 are considered very good; and 800 and up are considered excellent. Why is this important? Most people don’t have the thousands or millions of dollars in straight cash readily available when it comes to starting a business, or financing a house/car. A good credit score will enable you to (re)-negotiate terms of your loan, which includes better rates. More favorable interest rates on your loan will save you substantial amounts of money in the long run. 

Benefits to a good credit score include but are not limited to: better car insurance rates, getting a phone on contract with no security deposit, better chance for credit card and loan approval, and lower interest rates. Chances are more than one of these apply to you. 

How Do I Build My Credit Score? 

Well if you’ve yet to get a credit card and have zero previous credit history, the best way to start is to get a Secured Credit Card. 

Secured credit cards work because you pay a certain amount when you apply as a security deposit (let’s say $500), then your monthly credit limit would be $500. Don’t worry, you get your money back once you upgrade your card or close the account. This works because if you somehow spent $200 one month and could not pay, they already have your $500 to take from as a safety net. That’s why it’s easy to get approved for a secured credit card-virtually no risk for the bank. Also note that a secured credit card works just like a regular credit card, you will build credit history at the same pace. 

Some popular options include Capital One and Discovery. Some big banks such as Chase and American Express do not offer secured credit cards.

You can also become an authorized user. This usually applies to the younger audience who may find it difficult to get credit card approval. They can ask a parent or adult figure who has a credit card to co-sign them under their account. They would get their own card and in many cases, credit card issuers will report authorized users to credit bureaus, which adds to your credit file. 

For those who already have successfully opened a line of credit, the real work begins. Focus on:

1. Payment History: consistently pay off your routine bills on time, whether it’s a cell phone bill or restaurant costs. Every month you successfully conclude with no outstanding balance will bump your credit score up. 

• Payment history accounts for 35% of your FICO® Score, the score used by most lenders.

       2. Amount Owed/Credit Utilization: sometimes overlooked, the percentage used of the total monthly revolving credit limits (referred to as credit utilization ratio) is the next major factor of your credit score. Ideally, you don’t want to use more than 30% of your limit, 10-20% is ideal for improving your score efficiently. What this means is that, if you have a credit card with a limit of $1,000, you don’t want to put more than $300 on that card that month. This is especially important when you hear stories of people ‘maxing out’ their credit cards on a shopping spree- they are getting too close if not at their credit card limit. 

• Credit utilization makes up 30% of your credit score.

      3. Credit History Length: self-explanatory, the length you’ve held said credit accounts benefits the message you’re sending to a lender. A person with 20 years of good standing credit is much more attractive than a person with 2 years of credit history. There’s nothing much you can do to affect this other than applying for your first credit card if you’ve yet to get one. 

• Credit history length accounts for 15% of your credit score.

      4. Credit Mix: Diversifying where and how you spend your money. There are two types of credits to consider: revolving and installment. Installment credit are loans in a fixed amount where you agree to make monthly payments until it is paid off, it includes student loans, personal loans and mortgages. Revolving credit is associated with credit cards but can also include types of home equity loans. 

• Credit mix accounts for 10% of your credit score. 

      5. New credit: You can open up more credit cards. A benefit to this is less credit utilization (using $300 on two $1000 credit limit cards is better than using that on one $1000 credit limit account). Be aware that opening too many accounts at once can indicate increased risk, and will be more difficult to manage. Also note applying for credit lines require hard inquiries in your credit file, this may hurt your score. Only open new lines if the long term benefits outweigh the short term complexities. 

• Pursuit of new credit accounts for 10% of your credit score.

Bottom Line

Make credit card payments on time. Pay off your debts. Use your credit card in moderation. Resist spending on luxury items. Make sure you are not a victim of credit card fraud or any other inaccurate reports. A good credit score should be a goal that provides many benefits, some of the best being free flights/vacations. It’s frustrating how it may take years to build your credit score, but a fraction of that time to destroy your score through missed payments, foreclosure, bankruptcy, etc. Your credit score journey may be a one step forward, 3 steps back situation but the listed measures are tried and true ways of avoiding that pattern. It’s a process that requires time. 

If you are questioning your credit, consult professional help. At JCKLaw we specialize in debt resolution and have experience in bankruptcy. Call us at (718) 539-1100 or email info@jcklaw.com.