Most of us know what credit is right? A lot of us even know what a credit score means. But, why on earth does this affect whether or not you get a lower interest rate on a car loan or mortgage? Credit rating is important for a multitude of reasons, but simply put, it shows the people who are thinking about loaning you money whether or not you're capable of paying them back. In essence, it's a number that tells lenders how much to let you borrow and at what interest rate. That seems a bit silly right? It may be, but that's the system we have in place, and unless you're DAVE RAMSEY, you probably have either a car loan, mortgage, student loan or at the least, a credit card.
Listed below are the five different categories that affect your credit the most.
Do you pay your bills on time?
Bills refer to anything that you owe a lender that could potentially be reported to a credit bureau. Of course, most bills are sent out with a monthly due date. Look at the due date. Is it close? Pay the bill. This is the single most important thing you can do to keep your credit score in good standing. Can't afford it? Call the company that issued the credit. Whether it's a car loan, a retail credit card or student loans, a simple phone call explaining your inability to make the payment will most likely come out in your favor. Credit issuers can be understanding to your situation. They will most likely set up a payment plan that will decrease your payment, allowing you to pay the bill and keep your credit score from dropping. Failing to pay bills on time will almost always result in the company turning over your debt to a third-party collection agency. Fail to pay long enough, and you could even be sued by the creditor for the full amount of the debt. Think about that for a second. Not only will you be paying the amount of the debt, but court costs as well.
Do you have a low debt ratio?
Let's say that you have great credit. You pay your bills on time, but have a lot of credit cards. Let's pretend that you just lost your job and have to rely on those credit cards to survive until you find other means of employment. Altogether you have $25,000 left to spend on those cards. Six months have passed, but you still can't find work and you've spent almost $20,000. That's 80% of your available credit. At this threshold, your score will begin to drop as you're now seen as someone at greater risk for default based on your debt ratio. Try to keep a small balance on credit cards to avoid eating up your maximum amount of credit.
Check out this DEBT RATIO CALCULATOR to see where you stand.
How long have you had credit?
Remember when you got your first credit card? I don't either. But, this is important because obviously, the longer you've been using credit satisfactorily, the better your credit will be. Be careful about keeping very low or zero balances on your credit cards as this could cause your score to drop as well. Think of it like a game of Pac-Man. You have to play the game to score points.
What kind of credit do you have?
This category looks at the different types of credit that you have. There's secured and unsecured debt. Secured debt means that you've obtained a loan for a physical object such as a house, car, motorcycle or boat. This is secured because the creditor can actually seize the property if you fail to make payments. An unsecured debt refers to credit cards or student loans, where the lender can't actually see what you are doing with the money. If you successfully maintain a mix of these different types of credit, you're credit score will rise.
How often are you applying for credit?
The final category that weighs on your credit score is the number of times you have applied for credit in a certain amount of time. If you take out a lot of loans in a very short amount of time, this could be seen as a desperate act to pay off old loans with new loans. If you plan on making a large purchase such as a house in the near future, it may be a good idea to hold off on requesting new credit applications as this may affect whether you qualify for the loan.
What's a good score?
Credit scores average anywhere from 300-850 with the large majority of scores in the 600-700s range. Texas has the lowest average credit score of any state in the US at 650. If you are just starting to gain credit or have bad credit now, that would be a good goal to shoot for. Following these steps will ensure that your credit rating rises from there.
Where can I get my credit score?
Sure, the commercials are entertaining and the songs are catchy, but do not obtain your credit report from any of credit reporting companies advertised on television. Ever. They will actually charge you for services and give you a credit score as a bonus. That's like a company advertising a free cookie with the purchase of chocolate chips. And it turns out the chocolate chips are $15. Totally lame. Instead, visit ANNUAL CREDIT REPORT . This service was set up by the three major companies that monitor credit history; Equifax, Experian and TransUnion. They collaborated with the Federal Trade Commission to offer you one free credit history report per year for each company.
Fortunately, for those with good scores, it's easy to get lower interest rates, higher credit limits and approval for things such as cars, houses and unsecured loans. Remember, the less risky you appear to creditors, the more likely you are to be rewarded.