What All Adults Need to Know about Credit

Having good credit can help you qualify for a new credit card or get a car loan or mortgage with a low interest rate. Most people know that having good credit is important, but a lot of adults don’t know what factors are used to determine their credit scores or how to improve their credit.

How Credit Scores Are Calculated

Credit bureaus (Equifax, Experian, and TransUnion) collect data on debts and payment history. The credit bureaus, as well as other companies like FICO and VantageScore, use that information to calculate credit scores. These are the factors they consider:

Payment history

Before it decides to lend you money, a creditor wants to know if you’ll be likely to make payments on time, so it considers how you’ve handled credit in the past. A history of on-time payments will have a positive effect on your credit scores, while late payments, bankruptcy, or foreclosure will cause your credit to take a hit.

Credit Utilization Ratio

If you have a lot of available credit, that doesn’t mean you should use it all. A high credit utilization ratio can hurt your credit scores.

To figure out your utilization ratio, add up the balances on all your credit cards, then add up the credit limits for all your cards. Divide the first number by the second, then multiply by 100. That percentage is your credit utilization ratio. It’s generally a good idea to keep that number at or below 30%.

Mix of Accounts

Lenders want to see if you can manage different types of credit responsibly. Having credit cards and one or more installment loans (i.e., mortgage, car loan, student loan) and making all your payments on time can boost your credit scores.

Length of Your Credit History

The average age of your accounts influences your credit scores. Lenders and creditors want to know if you can handle credit responsibly over a long period of time. If so, that will reflect favorably in your credit scores.

Number of Hard Inquiries

When you apply for a loan or credit card, the lender or creditor will perform a hard inquiry and check your credit. Hard inquiries can cause a temporary drop in your credit scores.

Several hard inquiries in a short time might indicate that you’re struggling financially. If, however, you want to take out a mortgage or car loan and you get quotes from several lenders in a short span of time (about 2-6 weeks, depending on the company calculating your credit scores), all those requests for quotes will be counted as one hard inquiry.

Checking your own credit scores won’t result in a hard inquiry because you’re not trying to obtain a new loan or credit card. Therefore, it won’t have a negative impact on your scores.

Why You Can Have Different Credit Scores

Companies generally consider the same factors when they calculate credit scores, but they have their own formulas that weigh those factors differently. Also, companies that calculate credit scores aren’t necessarily using all the same information. A lender or creditor might report payments that you make to one or two credit bureaus, but not all of them.  

Things That Don’t Affect Your Credit Scores

Your income is not used to calculate your credit scores. A lender or creditor will ask about your income if you apply for a loan or credit card and will consider that information along with your credit scores.

The balances in your savings and checking accounts don’t affect your credit scores. Making purchases with a debit card won’t affect your credit scores because you’re paying with money that you already have in a bank account.

Your marital status does not directly impact your credit scores. You and your spouse will have individual credit reports and individual scores. If you take out a joint loan or open a joint credit card, the balances and payments associated with that account will be reflected in both of your credit reports and will affect your individual scores.

Carrying and Paying off Credit Card Balances

You might have heard that you have to carry a balance on a credit card to have good credit. That’s not true. You can make purchases every month and pay them off immediately to avoid interest charges.

You might assume that when you’ve paid off a large credit card balance, you should close the account. Doing that can harm your credit scores. Closing the account will reduce the total amount of credit you have available, which can drive up your credit utilization ratio. Also, if you’ve had the account for a long time and you close it, the average age of your accounts will decrease.

When you pay off a balance, it’s generally in your best interest to keep the account open. Don’t use the card, or make purchases occasionally so the creditor doesn’t close the account due to inactivity.

Are You Thinking about Buying a House?

If you’re interested in buying a home, having good credit is just one part of the equation. The homebuying process is complicated. Not knowing how to navigate it can lead to unnecessary stress and expensive mistakes.

The First-Time Homebuyer Masterclass will walk you through the entire process, from figuring out if you’re ready to buy a house to choosing the right property and mortgage. Click here to enroll.

Please share this blog on social media and/or send it to someone you know who is thinking about buying a house this year.