This article by financial expert and blogger Mary Beth Storjohann, CFP, author, speaker, and founder of Workable Wealth. She provides financial coaching for individuals and couples in their 20s to 40s across the country, helping them make smart, educated choices with their money.
Like it or not, your credit score is one of the most important numbers in your life, ranking up there with your Social Security number, date of birth, and wedding anniversary. This three-digit number is your financial report card, except there’s no getting rid of it after college.
Your credit score shows lenders just how trustworthy you are when it comes to managing your finances, and it can either save or cost you thousands of dollars throughout your life.
If you’re in the dark about just how significantly this number can impact you and the details behind your personal score, here’s an overview of what you need to know before hitting the mortgage application process.
How Your Score is Calculated
Your FICO credit score is comprised of five elements, according to the Fair, Isaac Corp.
- 35% of your score is attributed to how you pay your bills. Points are added for paying on time and deducted for late or missing payments. Note: This is a big portion of your score, so if you’re not paying bills on time, it’s best to get that under control pronto.
- 30% of your score is based on your credit utilization ratio. Translation: How much money do you owe as a portion of the amount of credit available to you? The lower this ratio, the better.
- 15% is based on the length of your credit history. When did you open your first account (and is it still open)?
- 10% of your score goes to the type of credit you have. Think revolving credit (such as credit cards) and installment credit (such as car loans and mortgages).
- The last 10% is impacted by new credit applications. How often and for what types of credit are you applying?
Where to Find Your Score and Report
To access your credit report, use a website such as annualcreditreport.com, which will give you one free report a year, or creditkarma.com, which will provide you with free access to your score upon signing up for an account.
Once you have copies of your report and score, immediately look for fraudulent or erroneous information. If you find anything, immediately contact both the credit reporting agency and the company that is portraying inaccurate information to determine next steps.
How Your Score Can Cost You
Your score can range from about 300 to 850. You’ll find a variety of breakdowns on what’s considered “good” compared to “excellent” versus “poor,” but in general you’ll want to aim for a score of 720 and higher, which is the “excellent” range.
The higher your credit score, the more creditworthy you appear to lenders (meaning they can rely on you to pay your debts and pay them on time), which translates into lower interest rates and more money saved when taking out a loan.
Not sure how this can play out financially? Consider this:
Meet Claire: She’s 35, pays her credit card off in full each month, has all her bills on auto-draft, and never misses a payment. She’s had a positive credit history for 10 years and wants to buy a home. Claire was approved for a $200,000, 30-year fixed-rate loan at 3.75%.
Meet Steve: He’s 32, obtained his first credit card at age 18, ran up some debt in college that he’s still working on paying down, and has no system for keeping track of bills. He has consistent late and bounced check fees. Steve wants to buy a home and was approved for a $200,000, 30-year fixed-rate loan at 5.5%.
What’s all the fuss about if they were both approved? Over the life of her loan, Claire will pay $133,443.23 in interest. Over the life of his loan, Steve will pay $208,808.08 in interest. A small interest rate difference of 1.75% translates into $75,364.85 more paid by Steve! $75,000 is a pretty significant sum of money that could be used toward other goals.
Having a solid credit score is one of the most financially savvy tools for you to have on hand when it comes to buying a home. When managed wisely, your credit score will bring you confidence, peace of mind, and more money saved via low interest rates.
When mismanaged or not cared for at all, your credit score can delay your success in meeting financial goals and result in additional funds and resources spent correcting past mistakes.