Everyone needs to know where they stand financially. This usually includes some form of monitoring, tracking, and/or budgeting of your finances. Even if you have a financial professional helping you, you need to know exactly what’s going on with your own finances because no one else will care more about your money than you will. But knowing where you stand financially goes beyond your assets and liabilities – it includes your credit.
Having a “credit history” generally means that you have at least one account that has been opened for at least the last six months. Whether you pay that debt in full, late, or not at all will determine your credit worthiness. Any open line of credit counts toward your credit history. For example, I have never had a credit card, but I have excellent credit because of my student loans that I promptly pay.
The good things about credit
Having good credit makes your life easier. You can easily get approved to take on more debt, including student loans, car loans, or a mortgage. Good credit also helps you get bills put in your name or rent an apartment. Finally, with good credit, you’re likely to get lower interest rates.
The bad things about credit
You need at least one line of credit open to have any credit at all. This encourages more debt. Additionally, a bad credit score can be a huge inconvenience if you’re trying to get set up with certain bills (you may need to put down a deposit). And bad credit can completely destroy your chances of getting approved for loans. It takes years to rebuild your credit.
Dave Ramsey and Suze Orman on Credit (this is my favorite part of this post!)
I’m a big time listener of both Suze Orman and Dave Ramsey. One specific thing that Dave Ramsey is big on is not being a slave to your debt. Your credit score is a reflection of how you handle your debt. If you have a lot of debt and you pay it on time, you get an excellent credit score. But if you pay cash for everything and have $1 million in the bank, you’ll have no credit score and therefore, have trouble putting bills in your name or renting an apartment. Suze Orman agrees that this makes absolutely no sense. And I agree with both Dave and Suze. I bring this up only because so often it’s tempting to follow the crowds without really paying attention to why.
So, in your quest for a solid financial foundation, I urge you to weigh the value of credit versus the risk of debt (Dave Ramsey would say pay cash and forget your credit score). While in some cases this may seem impossible, I know that I’m going to do whatever I can to pay off my student loan debt and never get a credit card. There are ways for banks to work with you without credit when you’re trying to get a mortgage, too (that’s the only thing that I really see a need of credit for – I plan to pay cash for everything else). These are all things to consider with respect to credit!
Suze Orman has a great thing going right now. She’s started a petition to get debit card transactions included on your credit reports. This would mean that your rent and bills paid by debit cards would be included in your credit report and score (but not other transactions, like groceries or shopping). This completely removes any “need” for a credit card if you don’t have any open lines of credit. I’ve signed the petition (along with 247k others). You can read more and sign the petition here.
The purpose of your credit score is to indicate how likely it is that you’ll pay your debt. Lenders use your credit score in determining whether to lend to you.
The FICO score is the standard credit score used in the United States and it’s calculated by Fair Isaac Corporation. Your FICO score is determined by a calculation that looks at all the information on your credit reports. This information includes: your payment history, the amounts of money you owe, the length of your credit history, new credit, and the types of credit that you use(d).
How to check your credit score
While you can get your credit report once a year for free from the three credit bureaus, you will probably have to pay to get your credit score. Usually, it’s no more than $20 to get your score. You can buy your score by going to one of the credit bureaus (Experian, Equifax, and TransUnion) websites and requesting your score.
Ranges and meaning of credit scores
While these numbers vary slightly, in general, you can use the following information below to determine what your FICO means to a lender.
Less than 500: Very bad credit
500-549: Bad credit
550-599: Poor credit
600-649: Fair/Average credit
650-699: Good credit
700-749: Very good credit
750 and up: Excellent credit
Your credit reports contain information that lenders reported to the three credit bureaus (Experian, Equifax, and TransUnion). Lenders report information, including: your payment history, the amounts of money you owe, the length of your credit history, new credit, and the types of credit that you use(d). Your credit report serves as a reflection of how you borrow money, which lenders use as a way to determine whether you’re currently lend-worthy. For example, if you apply for a credit card, the credit company will reach out to the credit bureaus for a copy of your credit report to determine whether they want to issue you a credit card and at what interest rate.
How to check your credit reports
You can get your credit reports for free from the three reporting agencies once a year from: AnnualCreditReport.com.
It’s usually recommended that you get one copy of your credit report from all three bureaus once a year. By doing this, you will know exactly what’s on your reports.
Analyzing your credit reports
When you get your reports, read them to see what has been reported, but also look for errors. If you have incorrect information on your credit report, you need to get it corrected. To do this, contact the appropriate credit bureau. The agency must investigate the dispute within 30 days of your request. Alternatively, you can write to the creditor disputing the incorrect entry.
Negative entries stay on your report for 7 years. After 7 years, the negative entries should fall off. If you have negative entries on your credit report that are over 7 years old, you should request to have that information removed by contacting the agency reporting the information or by contacting the creditor.
Fraud Alerts and Security Freezes
A fraud alert is something you can request to be put on your credit reports for a certain amount of time (usually 90 days, but up to 1 year or even 7 years). If you have a fraud alert on your report, it will signal to any lenders looking at your report that you may have been a victim of some sort of fraud (including identity theft). This signals to lenders to take extra steps to verify the legitimacy of the request for new credit. Fraud alerts are free, and they do not prevent lenders from checking and/or issuing credit.
A security freeze is like a “step up” from a fraud alert. If you request a security freeze on your account, you’re preventing lenders from checking and issuing you credit. It usually costs money to freeze your reports (roughly $5-$10 for each report but it varies by state), and it costs a similar amount to unfreeze them. The main reason for freezing your credit reports is to prevent the creation of new credit accounts. If you know you are not going to be opening any new lines of credit, you can freeze your accounts to prevent anyone else from attempting to do so. It’s a form of protecting yourself from identity theft.
All of my accounts are frozen because I am not going to take out any lines of credit in the foreseeable future. Further, I use my debit card (as credit), so I want to make sure that I’m protected as much as possible in the event anyone gets ahold of my account information.
Understanding credit is important, but understanding why your credit is important is even more critical to your financial success. Getting in the habit of checking your credit reports and score yearly is a supportive financial habit that I use to help me stay on track and know exactly where I am financially.