5 Things You Need To Know About Credit.
And what I’ve learned from seeing over 1,200 credit reports.
When I first started my career in finance, we were taught how to be both excellent advisers and excellent salesmen. In the beginning I remember being extremely eager to start closing loans, but my mentor in the industry told me, “The first sale isn’t when you close a loan, it’s when you get the credit report.”
I took his advice and started focusing on just that, and hundreds of credit reports later I’ve learned a tremendous amount about both how credit is ranked and people’s significant misunderstanding of it.
To clear up the confusion, I’ve made a list of some of the main credit tips you need to know to navigate your credit better.
1. Checking your credit report will not hurt your score.
The Fair Credit Reporting Act (FCRA) mandates that each of the three credit reporting agencies, Equifax, Experian, and TransUnion, must provide you with a free copy of your credit report once every 12 months.
If you make an inquiry regarding your own credit, there will be zero impact on your credit score. The only time there is an impact is when you make an inquiry while applying for an extension of credit, whether that being a mortgage, credit card, personal loan, or auto loan.
Additionally, most people find themselves worried about having a lender check their credit as though it’s going to lower their credit score 100 points and suddenly make them a high-risk borrower.
The truth is, “New Credit” or “credit inquiries” only account for about 10 percent of your credit score. The main factors determining how credit worthy you are boils down to your payment history and your credit utilization ratio.
Pro Tip: If you’re shopping around for a mortgage loan and you actually want a real quote and not a bait-and-switch “estimate”, it’s in your best interest to allow each lender to check your credit. The Consumer Financial Protection Bureau gives you a 45 day shopping period where any “Real Estate” related inquiries will be grouped together into a single inquiry at the end of the period, allowing you to shop for the best possible loan and while avoiding too many inquiries being added to your report. In addition, each lender will be obligated to send you a federally mandated loan estimate, which contains only the rates and fees they can actually offer. No B.S.
If you’d like to receive a free copy of your credit report without impacting your score at all, the best website to use, recognized and endorsed by the CFPB, is: AnnualCreditReport.com
Checking your credit report is a good idea so you can ensure the information is accurate and up-to-date, and so you can protect yourself against identity theft.
2. Your balance is more important than you think.
When I’m reviewing a credit report, the absolute first thing I’m looking for is your credit score. The second thing I’m looking for is your “credit-utilization ratio”.
This shows me how much credit you’re using relative to how much you have available, and the credit reporting agencies see this as the second most important metric affecting your credit (right behind actually making your payment on time).
Generally speaking, the more credit you tap into relative to what’s available to you, the lower your score is going to be.
This is because if you’re maxing out your cards and running the balance up high, it looks like you’re being irresponsible with your credit and biting off more than you can chew.
Pro tip: As a rule of thumb, you never want to exceed 30% utilization if you can help it, meaning if you have a limit of $1,000, you don’t want to spend more than $300.
Most importantly, make sure you are paying off your balance in full every month. You don’t want to carry a balance month-to-month because that’s when you start to accrue interest. Only use what you can afford to pay off.
By showing that you can hold back the temptation to use all of your credit limit, your credit card company is more likely to reward you with an increased limit, giving you access to more credit to leverage safely when you need it while still maintaining a healthy score.
3. Closing a credit card is generally a terrible idea.
Whenever I’m doing a debt consolidation loan, I like to ask my client “what’s the first thing you’re going to do once your debt is paid off?”
Typically there’s a short silence before they scream in excitement the exact opposite thing they should be doing, “I’m going to close my cards and start fresh!”
I love the enthusiasm and euphoria, but the problem is that the third most important factor determining a healthy credit score is the amount of credit history itself. I.E. how long the person has had credit for, on average.
Imagine you have three cards: one with 10 years of history, one with 5 years of history, and one with 3 years of history.
Your average credit history is 6 years.
If you close your longest established account, your credit history will drop to an average of 4 years and your overall credit limit will drop as well, which as we discussed above will have a negative impact on your credit score. No bueno.
Pro tip: If you’re worried about getting yourself into trouble with debt and that’s your reason for closing the account, as an alternative you could consider scheduling one of your recurring expenses on the card (a Netflix subscription, for example), setting up auto-pay linked directly to your bank, and either locking the card in a drawer where you won’t use it or cutting it into pieces so you absolutely can’t. This will allow you to keep your credit history alive, keep the card active, and still remove the temptation and ability to go deeper into debt.
4. Diversity counts.
One of the lesser-known metrics affecting your credit is simply the type of credit you’re using. Showing that you can responsibly handle multiple types of credit, such as a mortgage loan, auto loan, and revolving lines of credit, actually places you into a stronger credit position.
Credit account types include:
- Revolving credit: These are credit accounts that have different amounts due each month because you are charging different amounts. If you don’t pay the full amount due, your balance will begin to accrue interest. Credit cards are considered revolving accounts and if used properly can help you leverage your money and earn rewards for things you were going to buy anyway. Just don’t buy things you can’t afford to pay off at the end of the month.
- Installment accounts: Think auto-loans, personal loans, or student loans. Essentially this encompasses loans that begin with a set term and interest rate. You still don’t have to pay off the entire balance each month, but you will need to make the required minimum monthly payment or else your credit will take a hit.
- Mortgage accounts: Fairly straightforward. A mortgage is a loan on a house and is one of the best types of credit you can have as these loans are paid by the most credit-worthy individuals. Before buying a house there are many steps you need to consider first, as well as saving for a down payment.
5. No two scores are the same. It’s normal.
You may have heard the term “FICO” score before and equated it immediately with your “credit score”. While FICO is used by all three bureaus to generate a credit score for you, there are actually several different scoring models. FICO is just the brand name of a commonly used model, but a lender could ask for any FICO, FICO 8, FICO 9, FICO Auto and FICO Bankcard scores. The credit requested will vary depending on what type of credit you’re applying for.
A newer credit model used to determine credit scores is called the VantageScore. It’s a system that was designed in 2006 through a group effort between Experian, Equifax, and TransUnion, which aims to provide a competitive and more affordable alternative to the FICO model.
These different credit models explain why your score can be one thing while checking for a mortgage loan, but another while looking into auto-loan financing.
The other complication involved is the simple fact that not all of your information is furnished to each of the three bureaus. Some lenders only report to a single bureau, and the bureaus don’t like to share information between each other. Because of that, it’s possible for some bureaus to have less complete information about your report, and thus generate different scores.
No matter where you are in life, one thing stands true through it all: credit is vital to your financial success.
I hope this information helps you become more aware and knowledgeable when it comes to your credit, but I’d like to know your perspective as well. If you’re extremely credit-worthy, what are some tips you have on maintaining good credit? And if you’re on the other end of the spectrum, what are some of the things you’ve struggled with?
This article is for informational purposes only, it should not be considered Financial, Credit, or Legal Advice. NMLS#1670285
