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Understanding Debt Part 2

Understanding and Improving Your Credit Score

By James R. Cook, CFP®
Senior Manager, Large Employers & Mergers and Acquisitions

Last month, In Understanding Your Debt, Part I, we focused on reading your credit card statement. If you missed that article, catch up here.

While there are many types of debt, including home mortgages, car notes, and school loans, this series will continue to focus on credit card debt.

Continue reading to learn more about your credit score, and tips on how to improve it.

Understanding Your Credit Score

The higher your score, the better—-except in golf! A higher score is especially important when it comes to your credit score—-the higher, the better.

Your credit score is a statistical measure of your credit history created by one of the three major credit bureaus, Equifax, Experian or TransUnion. Your credit score may also be referred to as the Fair Isaac Co. (FICO) Score. However, FICO is not a credit reporting agency.

Lenders use your score to determine the terms (interest rate) they offer when lending money to you. Auto insurance companies in some states also use credit-based insurance scores to determine how likely you are to file a claim; thus, credit scores may also affect your car insurance rates.

The better your score, the better your terms for credit and insurance. This usually means a lower interest rate and lower car insurance premiums. So, a high score can save you thousands of dollars.

Calculating Your Credit (FICO) Score

There are several formulas used to calculate FICO scores, including proprietary data, from reporting agencies. However, there are six major categories, each with a different weighting, noted in ( ):

  • Payment history (35%): Do you pay your bills on time or after the due date?
  • Accounts owed (30%): How much money do you owe? How much credit do you have available?
  • Length of credit history (15%): How long has the account been open? How old is the newest account?
  • New credit (10%): Have you opened multiple accounts in a short period of time?
  • Credit mix (10%): Home mortgage, car loan, credit cards, etc.

Obtaining Your Credit Score

You are legally entitled to one free copy of your credit report each year from each of the three credit reporting bureaus. Although the three bureaus also assign a credit score for you, that score is not a part of your free report. The link below will take you to the U.S. government website that will simplify getting your reports. You will also find information on purchasing your credit score. Alternately, you can visit one of the three reporting agencies to purchase your credit score.

Most recently, some credit card companies provide your credit score with each monthly credit card statement.

Get Your Credit Report
Click this link to request your free annual credit report and information about purchasing your credit score:

Improving Your Credit Score

Your credit score is a reflection of your credit history over a number of years and it can take several years of positive credit history before you see significant changes in your score. However, if your score is not where you would like it to be, there are several steps that you can take now to begin improving it:

1. Improve your payment history: This basic step has a significant impact on your credit score. If you consistently pay late or miss payments, your credit score will be significantly, negatively impacted.

Fix it: Pay your bills on time. Set a system to manage your bills and payment dates.

It can be old-school, such as a shoe box where you gather all of your bills, or a more-high tech solution, such as an on-line bill pay/reminder app. The key is to put in place a system that makes bill paying as easy and as automatic as possible.

If you choose a manual system, list the due dates for each of your bills, in chronological order. Next, insert the dates and amounts of your paychecks. Review the list to cluster your bills together into two, or at most, three groups. Group by date, preferably around your payday(s), and then assign a date to pay each group of bills.

You are much more likely to be on time with your bills if you only have to pay bills two or three times a month and always on the same date, as opposed to treating each bill separately.
If you prefer a more high-tech approach, most banks now offer bill paying as an online option. With this more tech-focused process you can usually enter your regular bills just once and set the payment date. Your bills will be paid automatically each month unless/until you make a change.

2. Improve your ‘credit owed’ to ‘credit available’ ratio: Your score is impacted by the credit you owe and your total credit limit. For example, if you have three credit cards, each with a $10,000 limit, you have $30,000 in total available credit. If you currently have total outstanding balances of $25,000, you will likely have a lower credit score than someone with the same total available credit, but who is not near the limit on her accounts. There is no fixed formula for a good credit usage score, but generally, a lower score is better, because it reflects a lower level of indebtedness.

Fix it: Pay down your balance.

While this may seem obvious, it is really the best way to address this area. If you have used a significant portion of your available credit, it likely means that not only is your credit score lower, for most people, it also means that your family spending is out of balance.

The important thing to remember with an automatic approach is to have sufficient funds in your account to cover your auto-payment requests.

3. Manage your new and current credit usage: Individuals sometimes think that they can change their score in the short term by manipulating the number of accounts that they have or by making changes to their total credit limit. These strategies rarely work, and can often make things worse.

Fix it: Don’t open and close additional accounts

Don’t open additional accounts simply to increase your available credit in an attempt to lower your credit usage score, or cancel accounts just to reduce your available credit. The best solution is to maintain low balances on your cards and pay on time, building a strong history of responsible usage of the credit that has been offered to you.

Making It Work For You

Your credit score can have a significant impact on your ability to save money and manage debt. If you need additional help with debt or other financial issues, contact MMBB. Call us at 800.986.6222, or send an email and ask to speak to a Certified Financial Planner™ professional.