Your credit score. It’s important because it predicts the risk of lending you money. Potential employers, insurance companies, and landlords also use it when hiring, issuing policies, and renting.
A higher credit score gives you a better chance of getting credit cards, loans, and home mortgages. If your score is 740 – 850, you’re generally considered an excellent credit risk. But if your score drops to 620 or less, it’ll be difficult to get credit — or at least get credit at a low interest rate. The riskier you’re thought to be, the more interest a lender will want to collect to offset its loss if you ever stop making payments.
What affects your credit score? Investopedia highlights five components, each with a different weight:
Payment History (35%): Lenders rely on your promise to pay, and past actions indicate your promise’s reliability. So the more delinquent you become on bill payments, the lower your credit score will be. Your score also drops if a collection agency must be hired to force payments from you, if you default on a debt, or if your debt results in bankruptcy, debt settlement, foreclosure, a lien, wage garnishment, or a write off.
Amounts Owed (30%): The total amount you owe is a factor. So is the combined limit of your revolving credit accounts minus what you owe on those accounts. Finally, your credit score is affected by how you’ve handled both installment and revolving credit. You needn’t owe $0 on everything you ever borrowed to get a high score, but it’s better to owe $50 than $400 on, say, a credit limit of $500.
Length of Credit History (15%): Having a credit card or student loan, even as a freshman, isn’t all bad. Your score will rise as these accounts age — provided you don’t over-borrow and you make your payments as required.
New Credit (10%): Experience shows that people with cash-flow problems and/or planning big spending sprees often seek additional credit accounts. So applying for credit will drop your score for about year while lenders wait to see if you’ve overextended yourself. Nevertheless, lenders understand that consumers sometimes shop for lower interest rates on auto loan and mortgages, so occasionally seeking to refinance such debts is OK.
Types of Credit (10%): Having different types of credit helps raise your credit score. But it’s impact is small, so don’t seek new credit just to get a broader mix of credit accounts.
Student loans are installment loans in that repayment occurs in monthly installments. Borrow them conservatively, especially unsubsidized student loans. If, like most students, you can’t afford to pay interest that accumulates on them while you’re enrolled, they’ll magnify what you owe by eventually adding that interest to your loan principal. When you do begin repayment, pay off your student loans as quickly as possible, don’t miss payments, and don’t default.
Remember, your credit score will impact your ability and cost of borrowing for a car or home after college. So take great care to create, and keep, a high credit score.
We’ll be on spring break next week, but check out this website for a new article on Wednesday, March 25, from guest author Linda Matthew. Linda provides personal financial coaching through her own firm, Money Mindful, and is the author of Teach Your Children About Money.