101 Series: Credit

Credit is a fundamental aspect of your financial health, but it’s more than just a score on paper. For many, credit can shape opportunities, define access to important resources, and provide the freedom to achieve significant financial milestones. In this post, we’ll cover why building good credit is essential, how to use it responsibly, and the ways it impacts other parts of life, from housing and employment to relationships and mental well-being.

The Importance of Building Good Credit

Good credit is the foundation of financial security. A strong credit score signals to lenders, landlords, and even potential employers that you’re responsible and financially stable. Here’s why building good credit is so critical:

• Access to Better Loans and Rates: Lenders view a high credit score as a sign that you are less risky to lend to, which often translates to lower interest rates on loans. Whether it’s a mortgage, car loan, or personal loan, a strong credit score can save thousands of dollars in interest over the life of a loan

• Better Options for Renting: Many landlords and property managers use credit scores to evaluate applicants. Having a good credit score may be the difference between getting your dream apartment or being overlooked

• Greater Financial Flexibility: With good credit, you’re more likely to qualify for higher credit limits and various loan products. This flexibility can be helpful in emergencies or when you want to make large purchases

Building good credit takes time, often several years. However, don’t get discouraged if you’re just starting out - establishing good habits early can set you up for long-term financial health.

The Importance of Using Credit Responsibly

Building good credit is only part of the picture—using it responsibly is just as crucial, if not more. Credit is a tool, and just like any tool, it’s only beneficial if used correctly. Irresponsible use of credit can lead to high debt, low credit scores, and increased stress. Here’s how to make the most of it:

• Avoid Carrying High Balances: Credit utilization, or the amount of credit you use compared to your total available credit, significantly affects your score. Staying below 30% utilization is generally recommended, though lower is even better. Carrying high balances not only hurts your score but can lead to paying significant interest over time.

• Make Payments on Time: One late payment can have a substantial negative impact on your credit score. Setting up automatic payments or reminders can help ensure you never miss a due date. Your payment history is the most important factor in your credit score, so consistency here pays off.

• Avoid Unnecessary Credit Inquiries: Each time you apply for credit, the lender performs a hard inquiry on your report, which can slightly lower your score. Avoid opening too many new accounts at once, and only apply for credit when you genuinely need it.

By using credit responsibly, you keep your score strong and build trust with lenders and other financial institutions, making it easier to access credit in the future when you need it.

How Credit Impacts Other Aspects of Life

A person’s credit health goes beyond just financial transactions; it can influence various parts of one’s life in subtle but significant ways.

• Housing Opportunities: As mentioned earlier, landlords often use credit scores to screen tenants. Low credit could limit your housing options, while a strong score can provide better choices and negotiation leverage. In competitive housing markets, good credit is often essential.

• Job Prospects: Some employers review credit history as part of the hiring process, particularly for positions that involve financial responsibility. A negative credit history can sometimes raise red flags about reliability and trustworthiness, potentially impacting employment opportunities.

• Cost of Insurance: Insurance companies may use credit information to determine rates. A poor credit score can lead to higher premiums, particularly in auto or homeowner’s insurance, as insurers often see a correlation between financial responsibility and risk levels.

• Mental Health and Relationships: Financial stress can impact personal well-being and relationships. Struggling with debt or facing credit issues can cause stress, impacting mental health and even relationships. Discussing finances openly with partners, budgeting together, and understanding each other’s financial histories are key to ensuring credit and finances don’t strain relationships.

How the Credit Score is Calculated

Credit scores are calculated using five different aspects: payment history, credit utilization, length of credit history, credit mix, and new credit/hard inquiries. There are two major methods of calculation, the FICO score and the Vantage Score. Below we’ll dive deeper into how the Vantage Score is calculated.

• Payment History (35%)
  • This is the most significant factor in scoring, tracking whether you pay your bills on time
  • Late or missed payments, defaults, and accounts in collections can negatively impact your score; inversely, consistent on-time payments can improve your score
• Credit Utilization (30%)
  • Credit utilization is the percentage of your credit limit that you’re using, calculated by dividing your total outstanding debt balances by your total credit limit
  • A good rule of thumb is to keep your utilization below 30%, with below 10% being excellent
• Length of Credit History (15%)
  • This considers the length of time you’ve had established credit, looking at the average age of your score, your youngest account, and your oldest account
  • The longer, the better - six plus years is good

• Credit Mix (10%)
  • Credit mix refers to the variety of accounts: credit cards, loans, mortgages, etc
  • Just like you like a variety of foods on the menu of a restaurant, lenders like to see you have experience managing a range of credit products
• New Credit/Hard Inquiries (10%)
  • Each time you apply for credit, a hard inquiry is added to your account
  • Opening too many accounts at once can adversely affect your score, signal to lenders you are experiencing financial instability, and reduce the average age of your accounts

Building Good Credit is a Lifelong Journey

Building good credit is a marathon, not a sprint, and building good habits today can have significant payoffs down the road. Whether you’re just starting your credit journey or aiming to improve a challenging credit situation, taking small, consistent steps can make a difference.

Being aware of the power of credit—and using it wisely—can help you access financial opportunities, achieve milestones like homeownership or starting a business, and contribute to your overall financial stability and peace of mind.