Why Your Credit Score is so Valuable

If you are under twenty-five, odds are you don’t think about your credit score much. However, it is likely that you will need a good credit score to purchase big ticket items at some point in the near future. Cars, homes, or general access to money (perhaps for starting a business) are all connected to your credit score.

On average, people with a credit score of 760 or more pay about two percent less interest than someone with a credit score of around 600-630. If someone were to buy a car with a credit score of 760, they would have an interest rate of about six percent. On the other hand, if someone with a credit score of 600-630 wanted to buy a car, they would probably get an interest rate of around eight percent when purchasing a new vehicle. If both parties bought a brand new car worth $40,000 and both took five years to pay off their car loan, the person with a 700 credit score would pay $13,529.02 in interest, and the person with the lower score would pay $18,773.12. This is a $5,244.10 difference. That’s a lot!

Below, we’ll cover one of the best ways to build credit, which is by using a credit card. A credit card is one of the best financial tools for anybody looking to better their financial future. However, it must be used wisely!

Here are some common myths about credit cards

Myth #1: Asking for your credit score hurts it

This is false! Fortunately, there are free sites where you can look at your credit score without hurting it. Your score will only be affected when a third party asks for your credit report when you apply for a line of credit, a credit card or a loan. This will only be a temporary 5-10 point drop in your credit score. This isn’t a major issue and is something your score can easily recover from. Unfortunately it cannot be avoided because people will always need to check your score when you are asking for loans or lines of credit. One of my favourite sites where I can view my credit report without getting penalized is credit karma.

Myth #2: Paying the minimum payment raises your credit score

Not true! I have seen many of my friends make the mistake of only paying the minimum payment. Paying the minimum payment is detrimental because carrying a credit card balance from the previous month into the next month will cost you in interest and increase your credit utilization. Credit utilization is one of the main factors used to calculate your credit score. You want to keep your credit utilization as low as possible. We’ll discuss this more below.

How is your credit score calculated

Five factors impact your credit score: new inquiries, payment history, credit utilization, the length of your credit history and your credit mix.

New Inquiries

A new inquiry occurs when a third party, such as a bank, checks your credit report when you apply for a loan, line of credit, or credit card. New inquiries make up ten percent of your credit score.

Payment History

Your payment history accounts for thirty-five percent of your score. To keep your score up, you must make payments and pay your credit card off in full each time. Failing to pay your credit card bill on time is highly detrimental to your score. Missing mortgage and bill payments will also lower your score.

Credit Utilization

Your credit utilization makes up about thirty percent of your credit score. Credit utilization is the amount of your available credit that you are using. You want to keep your credit utilization under thirty percent to keep your score as high as possible. Companies like to see that you are using only some of your available credit, as it can be perceived that you are overleveraging yourself when you are using most of your available credit. I recommend requesting credit limit raises every six months and applying for new credit cards regularly so you can keep your credit utilization as low as possible.

Credit History

Your credit history, which includes the age of your credit cards, loans, and lines of credit, makes up about fifteen percent of your credit score. Creditors want to see that you can maintain debt and keep paying it off over a long period of time.

Credit Mix

Your credit mix determines ten percent of your credit score. A credit mix is the variety of your credit accounts, such as loans, credit cards, and mortgages. Companies want to see that you have a credit mix with various credit tools and that you can manage and use them effectively.

SIX ways to ensure your credit score is high and that it stays high:

1. Pay off your credit card in full each month. You can set up reminders and auto deposits so you never miss a payment.

2. Spend only what’s in your bank account – Treat your credit card like a debit card. DON’T SPEND MORE THAN YOU HAVE!

3. Make a budget and only spend the amount of money that you allocate into your budget. Not only will this help you keep track of what you spend. It will help you spend less because it shows you the little things that you may waste your money on.

4. Try to keep your credit utilization below 30%. You can do this by having multiple credit cards, which will, in turn, raise your overall available credit.

5. Apply for credit increases and new credit cards regularly to grow your available credit. However, don’t make too many new credit inquiries simultaneously, as this can lower your score.

6. Do not close out accounts that have been opened for a while, which shows you have a good credit history. This shows creditors that you have been able to manage your credit over a long period of time.

Picking the right card for you:

Picking the right card for you is integral to getting the most out of your credit card. Different cards come with different perks, reward systems and annual fees. You should pick a card that has the best reward system that aligns with your goals.

Cashback

Cashback is where credit card companies give you a percentage of money back on the amount you spend on your credit card.

Rewards points

Credit card companies partner with many companies, and you can earn rewards points when you spend money on your credit card. You can earn and use your reward points to purchase from some of the companies your credit card company partners with. Credit card companies will sometimes give you more points for shopping at their associated companies when using your credit card. So, it is important to analyze where you spend your money and apply for a credit card that will give you the best value.

Friendly advice: Only get a card with an annual fee if the rewards and perks you are expected to get from the card will outweigh the annual fee cost. Plenty of cards out there with no annual fee provide great rewards. If you are not spending a lot, a card with no annual fee is probably best for you.

How I picked a card for myself

I recently moved out for school and am now adjusting to my new life, which comes with paying for groceries, gas, bills, and entertainment. Knowing that one of my main expenses would be groceries, I looked for a credit card that gave extra points for shopping at the grocery store near my apartment, and conveniently, I get extra points for eating at some of my favourite restaurants with this card as well. In getting the right credit card for yourself, you are spending money that you had to or were going to spend anyway, but are getting rewarded for spending it with your favourite companies. I love credit cards for this!

What else affects your credit score besides your credit card?

If you fall behind on your phone bill for 3-4 months, it will get reported on your credit score. Thus, your credit score will decrease. You must pay all your bills regularly to ensure your credit score remains high.

Here are some other things you should consider: Instalment loans (student loans) and mortgages are two other main factors besides your credit card that can affect your credit score. Ensure if you are taking out a loan or mortgage that you have done the math and will be able to make the payments regularly and on time so your credit score can remain healthy. You should have an emergency fund of at least two months of expenses to ensure you can cover your payments for a month or two if something unexpected comes up in your life.

Conclusion

In conclusion, your credit score is a powerful financial tool that can significantly impact your ability to afford the expensive things you desire. Maintaining a high credit score opens doors to lower interest rates, saving you a lot of money over time. This is why you should educate yourself on the factors that affect your credit score and the different types of credit cards that are out there to ensure your score is as high as possible while getting the most benefit from your credit card.

About the Author:

Caleb R

I am passionate about personal finance. It is my goal to empower young people with knowledge to help them make better financial decesions and get the most out of their money.