Credit 101: Using Credit Wisely

Having good credit is beneficial for many different milestones and purchases throughout your life—from applying for a mortgage to selecting car insurance to signing up with a new internet provider. Knowing how your credit score is determined can help you build up and maintain yours. 

The Basics

You can look at your credit report as your personal financial report card, and you can think of your credit score (a three-digit score ranging from 300 to 850 that’s meant to indicate to lenders how risky you are as a borrower) as your overall GPA. Every time you pay down your credit card balance or repay a loan, the transaction is reported to the credit bureaus and counts toward your total score.

A good credit score helps position you as a trustworthy, responsible customer. A low credit score can have significant implications on your ability to access credit and may even result in higher interest rates and down payments because you will be considered a "high risk" borrower.

You can request your credit report from one of the three national credit bureaus: Experian, Equifax and TransUnion. You are entitled to one free copy per year, or within 60 days of being rejected for credit, employment, insurance or rental housing due to bad credit.

Typically, your credit report will not include your credit score; however, there are three primary ways to access your credit score:

• Check your credit card statement or other loan statements.

 

• Talk to a nonprofit credit counselor or housing counselor.

 

• Use a credit score service. These can be either paid or free.¹

 

How Your Credit Score Is Calculated

Your credit score is based on a number of different factors, including:

• Payment history – Paying your bills on time often has the greatest impact on your credit score.²

 

• Credit utilization ratio – This is the sum of all of your outstanding credit balances (i.e., your total debt) divided by your total credit limit—in other words, how much of your total available credit you are currently using. For example, if you have a balance of $1,000 on a card with a $5,000 limit, your credit utilization ratio for that card is 20%. Generally, the lower your utilization ratio, the better.

 

• Length of credit history – The longer your credit history, the better, so make sure to start building credit as early as possible.

 

• Total open lines of credit and types of credit used – There are several types of credit that can influence your credit score. In addition to credit cards, your credit score takes car loans, mortgages, student loans and several other forms of debt into account.

 

• Number of hard credit inquiries – Checking your own credit may not affect your score, but there are a lot of other people who might be requesting a report on your behalf. Every inquiry made by a third party in your name in connection with an application for credit can have a negative impact on your score, so try to keep these to a minimum.

 

Winning Plays for Keeping up Your Credit Score

Fortunately, there are several things you can do to maintain or improve your score. Here are some winning plays to keep your financial report card in good shape:

• Avoid late payments. Late payments on anything from medical and electric bills to credit card dues and monthly rent can cause your credit score to drop and may be noted on your credit report for up to seven years.

 

• Avoid canceling credit cards. Canceling a card will decrease the amount of total credit in your name and lower your credit utilization ratio as a result, even if you have no balance on a card.

 

• Avoid applying for several credit cards at once. Credit institutions record all credit inquiries made in your name. Multiple hard inquiries within a short amount of time can suggest that you might be "high risk," which may have a negative impact on your score.

 

• Automate payments. Set up automatic payments for your credit cards to avoid being penalized for late payments.

 

• Make copies. If you know that several people will be inquiring about your credit within a short period time (i.e., when moving or applying for a loan), offer to send them a recent copy of your credit report instead of having them each make a formal credit inquiry on your behalf.

 

• Be cautious when co-signing a loan. If your co-signer defaults on a payment, that could also have a negative impact on your score.

 

• Review your credit report annually. Many credit reports have mistakes that could result in a lower credit score, so make sure to request a report once a year. Not all institutions report to all three credit bureaus, for example.

 

The Bottom Line

Whatever your starting point is, don’t underestimate the power of these three digits, and remember that it’s never too early to become knowledgeable about your credit. If you have any questions, a Financial Advisor can help you establish a solid credit foundation and incorporate that into a plan to reach your individual goals.

Footnotes:

¹ Consumer Financial Protection Bureau. “Where can I get my credit scores?” Available at https://www.consumerfinance.gov/ask-cfpb/where-can-i-get-my-credit-scores-en-316/.(opens in a new tab)

² Experian. "What Affects Your Credit Scores?" Available at https://www.experian.com/blogs/ask-experian/credit-education/score-basics/what-affects-your-credit-scores.(opens in a new tab)