Credit – Who is keeping score?

In my financial webinars and coaching, many people ask about their credit score and the reasons they should be concerned about it.

A credit score is the numerical value calculated from information in your credit file that is used by lenders and landlords to assess your “credit risk” at that time. A credit report is a summary of your financial reliability—for the most part, your history of paying debts and other bills.

Do you know exactly how your credit score is determined?

Click here to see: What is your credit score composed of?

Your credit score matters because the number you have which ranges from 300 to 900  reflects your creditworthiness to potential lenders. Higher scores make you more likely to qualify for better rates on things like mortgages, credit cards and loans, potentially saving you hundreds and even thousands of dollars.  When it comes to something like a 25-year mortgage, any saving on interest rates is significant.

Credit use or utilization

A large part of your credit score (30%) is based on how much of your available credit you’re using. This ratio of credit or loan balances to credit limits is known as your credit utilization. The higher your credit utilization, or the closer your loan balances are to your credit limit, the more your credit score is hurt. Most experts will tell you to keep your ratio below 30%.  This rule is helpful because it gives you a reasonable goal and data shows that the lower your ratio is, the higher your credit score will be

Note that your credit score is composed of a number of factors. If your overall credit profile is in excellent condition, it’s unlikely that your credit score will plunge if your credit utilization ratio rises to 31% one month. But if you occasionally miss payments, have too many inquiries on your credit report or are new to credit, then utilizing more than 30% of your available credit will likely have a more harmful effect on your score.

It’s also important to keep in mind that your utilization rate is the percentage of credit you’re using across ALL of your loans and credit cards. In other words, your utilization is calculated by totaling all of the balances you carry across each loan you owe; in other words, when it comes to credit cards specifically, you don’t have a separate utilization rate for each card.

So if you’re carrying a $2,000 balance across three credit cards with a total available balance of $6,000, your utilization rate is 33 percent – even if you’re using 50 percent of one card’s limit and 10 percent of the other cards’ limits.

You can improve your score in these not so intuitive ways:

Ask your card issuer for a credit limit increase: getting a credit limit increase can be a great way to lower your utilization with limited effort on your part. And if you’ve used credit responsibly until now, there’s a good chance they will grant your request. Once you get that bigger credit line, remember not to increase your spending as well, or else you could negate the positive effects of having a larger limit.

Pay off cards with smaller balances but do not close the account:  Put the cards with zero balance in a drawer and use just one card going forward.  In this way you’ll still have the larger credit limit but use less of it, likely improving your credit score.

Be sure to use your credit cards at least a bit:  Although keeping your utilization at zero percent might seem like the best way to go, banks may actually frown on it. Remember, they want to see that you’re using credit responsibly – not avoiding it altogether.

Contact us for more information on financial webinars and seminars in the workplace. As always, you can reach me by phone at 905-707-5220.

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