CREDIT SCORE

Your credit history is the single most important aspect of your finances.  Your credit history is what determines how favorable your terms will be on a loan.  Unfortunately we all need loans.  Most people can’t outright buy a house or even a car.  And starting a business is just as expensive.

 

There are two main components to your credit history: your credit report and your credit score.

 

Your credit report lists all your basic financial information: all your accounts, credit cards, loans, bankruptcies, past payment history.

 

Your credit score (often called a FICO Score) is a number that represents your credit risk.  The scale usually ranges form 300 to 850, and the higher the score the better.  Your score is mainly based off how successfully you pay back money you’ve borrowed.  If you pay your credit card bills and car payments on time, your score will go up.  Fail to pay, and your score goes does.  The score exists to show lenders how reliable you are.  If you want to check your credit score, I recommend Credit Karma (www.creditkarma.com), they are free and easy to use.

 

Lenders will analyze your credit report, credit score, current salary, and age to determine how much to lend and at what interest rate.  A better credit history allows you to have lower interest rates and will save you a substantial amount of money over the years.

The main difference between a lower-middle class, middle class, and upper-middle class person is not their income, it’s their credit score.  Just because your neighbors drive a BMW doesn’t mean they make more money than you.  They probably just have a better credit score.  Their higher credit score allows them to make smaller payments. 

 

Everyone is always trying to save money here and there by not dining out or wearing the same pair of shoes until they disintegrate.  These kind of people fail to see the big picture.  Those little purchases are not going to break you.  It’s the big purchases that set you back.  And if your credit score is terrible, those big purchases become even bigger.

 

Here’s a simple example.  Say you’re buying a house.  You’ll do a 30-year loan with your bank.  If you have good credit, the bank says you can pay them $1000/month.  If you have bad credit you pay $1300/month.  At first glance, a $300 difference doesn’t seem that bad to get your own house.  But when you think about it, for $300 you can buy a new big screen TV every month for thirty years.  Or go to Disneyland every month.  And when you look at the big picture, it looks even worse:

$1000/month  x  12 months  x  30 years  = $360,000

$1300/month  x  12 months  x  30 years  = $468,000

Holy shit.  Over thirty years that’s a difference of $108,000.  Wouldn’t you like to have an extra 108k when you retire?  That’s two BMWs, going on a cruise every year, and a pool in your backyard.  That’s a nice life.  Like I said, your neighbors don’t make more money than you, they just save more money because they have a better credit score.

 

So I’m going to tell you the easiest way to increase your credit score.  I’d prefer if you just paid off all your bills but here’s a cheat code.  One of the factors that determines your score is known as Amounts Owed.  Basically how much money you owe.   Which for most people is their credit card debt.  But the score also factors how much credit you aren’t using.  For instance:

 

If your credit card limit is 5k and you’ve used up 3k.  You would be using 3/5ths of your available credit.  Now say your credit limit was10k, but you still only use 3k.  You would be using 3/10ths of your available credit.  All of a sudden, it looks like you’re a responsible person.  You have a lot of credit available but you choose not to use it.  This demonstrates you have self-control and restraint.  Even though your spending habits have not changed and you still spent 3k.

So the easiest way to increase your credit score is to increase your available credit.  Call your credit card company and ask for a limit increase.  I’m serious, do it now.  Pull out your credit card, call the number on the back, and do it.  Most of the time you don’t even need to speak to a person, it’s automated.  You will be asked the same two questions.  What’s your income?  What’s your monthly rent?  They don’t validate any of your answers.  They just input it into their formula.  So feel free to add to your income and subtract from your rent to better your results. 

 

They’ll ask how much you wish to increase your limit by, say 5k and see what happens.  If they say they can’t go that high, they’ll then offer you their max.  Take the max.  And then once a year, you’re going to call back in and raise your limit again.  The longer you’re with them, the more likely they’ll just keep raising it.

 

And I feel compelled to say: this cheat code only works if you don’t actually use the credit.  Don’t increase your limit and then spend it all, that defeats the purpose and will make things much worse.

 

Here is the entire credit score formula.  This is how your score is computed:

Payment History             35%

Your history of paying bills.  Do you pay in full?  Do you pay on time or late?

 

Amount Owed                30%

How much you owe and how much credit you have available.  Also known as your Credit Utilization Rate.

 

Length of History           15%

How long have you had credit?  Having older accounts are better, because this shows you are stable and reliable.

New Credit                       10%

New credit inquiries and recently opened accounts work against you.

Types of Credit                10%

A variety of credit is better.  Do you have credit cards?  Car payments?  Mortgage?