Why Credit Scores Are Important

Your credit score… that area of personal finance that you know you should be more on top of, but never get around to it. Well now’s the time to.

Did you know that a bad credit score can cost you thousands of dollars?

Or that a good credit score can save you those same thousands of dollars, and potentially help you earn thousands of dollar on top of that?

Well now you do! The good news is that it’s relatively easy to automate checking and tracking your credit score, which we’ll cover below. It’s also quick and easy to learn all the basics of credit scores. But first let’s review why they’re so important.

Credit scores are used more often than you think, and for most people they only realize they have a problem (and it’s gonna cost them!) when it’s too late to immediately fix up their score.

The biggest areas of your life where credit scores have an impact:

1)   Buying a Home: A good score can mean the difference between getting approved or denied for a mortgage for the purchase of a new home. And it can also mean securing a lower interest rate. A few percentage points on a mortgage interest rate doesn’t sound like a lot, but it adds up very quickly since it’s applied to borrowing amounts of $50,000, $100,000, or several $100,000s. A good score translates to savings of thousands of dollar per year in interest.

2)   Other Loans: The same logic applies to all other loans, like car loans, student loans, home improvement loans, etc. The better your score, the lower your interest rate, the less you pay.

3)   Credit Cards: For most credit cards, you’ll need a decent credit score to be approved. A credit card is beneficial because it essentially gives you a short, free loan every month, which can be useful. The real benefits of credit cards comes into play when you have a good credit score or better (over 700), which makes you eligible for excellent rewards credit cards. Used the right way, you can leverage high value rewards credit cards to earn a few thousands dollars a year towards entertainment a travel. It’s a great way to pay for recreation while putting your own hard earned money into savings or towards non-discretionary expenses like housing and bills. 

4)   Other Areas: Your credit score also comes up in a several other areas, such as

  • Employment Screening
  • Insurance
  • Renting an Apartment or Home

Now that we’ve seen why credit scores are important, here’s what you need to know about them:

A)   How to check your score

B)   How to monitor your credit

C)   How your credit score is calculated

D)   Ways to improve your credit score

 

I. How to check your credit score

The fastest and best way to check your credit score is online through a reliable service. And it should be free. But what service to use? Seems like there are so many out there, constantly bombarding us with TV commercials and online advertisement or fake news articles that are actually advertisements. Woman uses 1 simple trick to boost her credit score 283 points!

After doing a lot of research of the subject, I’ve found 2 websites that meet our criteria… They are Credit Sesame and Credit Karma. Both are completely free to use, and they offer credit score estimates based on information from a credit bureau. Credit Sesame and Karma also allow you to monitor all your credit activity, and will send you emails notifying you of any changes that happen. I’ve been using both for a few years now.

Signing up is quick and easy, although you do have to provide a lot of personal information. It’s good to know that both websites use strong data protection and are very secure.

II. How to monitor your score

Once you create an account with Credit Sesame or Credit Karma, enable credit monitoring and email notifications. Now you’ll get notified of all important activity. Knowledge is power, and you’ll be able to take action based on that information to build and maintain good credit. Boom, another system for securing a good credit score; which is a key part of building your personal wealth.

III. How your credit score is calculated

How the heck does your credit score actually work though? A mystery to most people, it’s actually not as complex as you’d think… Your score is a combination of different components. Each component makes up part of the total score calculation, and some components have a stronger effect on your score than others. The effect a component has on the credit score calculation is called its weight. So for example, the component Payment History, which tracks if you’ve been paying your bills on time, has the strongest effect on your credit score, and its weight on the calculation is 35%. All of the components weights added together equal 100%. Here they are:

  • 35% Payment History
  • 30% Amounts Owed
  • 15% Length of Credit History
  • 10% New Credit
  • 10% Types of Credit

Check out the FICO website to learn about what goes into the calculation of each component.

IV. Ways to Improve Your Credit

An ideal credit score falls within the top two credit score ranges (Good & Excellent), and is above ~700. If your score is below this, you’ll probably pay for it in terms of higher interest rates on loans. And you won’t have access to high rewards credit cards that you can use to earn thousands of dollars a year for yourself.

So if your score falls below that good or excellent range, it’s definitely worth it to put some work in to improve it. What you’ll need to do to improve depends on the issues that are hurting your score. So the first step is to research your credit report, which you can get for free from www.annualcreditreport.com. After you’ve researched your report and identified the negative items, it’s time to get to work on repairing and/or building your credit.

My favorite site on that topic is Credit Info Center; it’s filled with excellent, detailed strategies on credit repair and building credit.

 

Credit Scores aren’t the most exciting personal finance topic in the world, but it doesn’t take too much work to make sure you have a good one, and it’s worth the energy required to repair or rebuild your credit if your score is below 700. The rewards are definitely large in comparison to the investment of time and effort, making it a classic investment with an outsized return in your personal finances.

 

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