Why is a credit score so important?
While there may be many answers to this question depending on your perspective, the top of anyone’s list should include how much it can save you!
How much you pay in interest on any loans will be directly impacted by your credit score, so knowing your score and how to improve it over the long-term is critical to your financial well-being.
Your Credit Score by Liz Pulliam Weston is a great source to get a handle on your score and how to improve it. Additionally she helped dispel a few misconceptions that many of us have regarding our FICO score including:
- Your score is not penalized by checking your own score
- Shopping around is not dangerous – the FICO formula groups auto and mortgage applications that occur within a 30 day window (do it all in 30 days!)
- Bankruptcy is not the end of the world! – granted you may pay through the nose but it is possible to get credit after facing bankruptcy
The author also packed the book with lots of information that will help you understand how the scores are calculated and improve them in the process:
- Pay ON-TIME! While creditors will generally only report you to the credit agencies after you are 30 days late, every day counts in the big picture
- Manage your debt across all accounts. From the perspective of your FICO score you are better served to have a little debt on several cards than moving all your debt to one creditor leaving you with a low credit to debt ratio. (See the first point below for more)
- Maintain your credit relationships – Maybe you have paid off a credit card and they raised your rates. While you can’t wait to say good-bye, think twice, the age of your relationships have an impact!
The most interesting information however was the explanation of how FICO scores are calculated. There are 5 major components in how your FICO score is calculated including:
- Debt Load – 30% of your score is based on your debt load. FICO considers both your total credit to debt ratio in addition to each individual credit to debt ratio, either can bite you.
- History – 35% of your score is based on your ability to pay your bills in a timely manner. Noted above, every day counts!
- Aging – 15% of your score is based on the age of your accounts. Unfortunately this means that once you have a built a relationship with a creditor you are kind of stuck.
- New Credit – 10% of your score is based on how many credit reports are pulled and how often. Too many raises a red flag!
- Credit Types – 10% of your score is based on the types of credit you have. FICO wants to see a nice balance of credit types including mortgage, auto and credit cards.
How has this book changed my perspective most? Living a cash life may not be such a great idea. Maybe if you have as much money as Dave Ramsey then FICO won’t matter, but for the rest of us there will probably be a future need of a mortgage or other debt. When that day comes, showing that you can manage your money responsibly means that you will have to show you have actually used debt.
This book makes a great case for using credit cards routinely to maintain and build your FICO score, however we are still welcome to pay them off immediately!