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One of the most important aspects of personal finance is having and maintaining good credit. Your credit is so important because not only does it affect the rates you pay on home loans and insurance but it also can affect whether you get a job. More and more employers these days are using credit to determine if you get that job you are applying for; especially if the job involves handling money or dealing with sensitive personal and financial information of others.
Most companies correlate a good credit history with your level of responsibility and financial character. A good credit score would indicate to a mortgage company that you will be likely to pay your monthly mortgage payment on time every month. A good credit score to an insurance company would indicate that you will be less likely to file numerous insurance claims. A good credit score would indicate to an employer that you will be more trustworthy, show up for work and less likely to do something that would not be against the rules. Usually this is a pretty good indicator but not always the case. Someone with a low credit score could be just as trustworthy as someone with a high credit score.
The Credit Score.
If you apply for a mortgage, credit card, loan or insurance, most lenders will check a three digit score called your FICO score. This score ranges from 300 - 850. Of course, higher scores are better with anything over 720 considered excellent. According to MyFico, most consumers fall in the range of 650-799. Consumers with higher scores will get much better interest rates than those with a lower score.
How much could you save on your home loan with different credit scores?
- 30 Year Fixed Rate $200,000 Mortgage in Georgia
- Rate w/ 720 credit score - 6.474% - Monthly Payment $1261 - Total Interest $253,589
- Rate w/ 620 credit score - 8.283% - Monthly Payment $1507 - Total Interest $342,583
- The 100 point credit score difference will cost an additional $246 a month and you will pay an additional $88,725.
- With the current credit crunch, it will be alot harder to get a mortgage with a 620 credit score!
How do you get and maintain a good credit score?
- Pay Bills on Time. This is 35% of your Fico score. Having just one late payment can send your score into a downward spiral. Once single late payment can stay on your report for 7 years.
- Good Mix of Credit. This is 10% of your credit score. Having a good mix of installment loans, credit cards and mortgages is good for your credit score. This is really important if you have a short credit history. Obviously, you should not apply for new credit just to have different types of credit if you don't need it. This will actually hurt your credit in the short term.
- Debt to Credit Ratio. This is 30% of your credit score. The closer you are to maxing out your amount of available credit, the more negative the impact to your credit score
- Length of credit history. This is 15% of your credit score and is something that simply improves with age. The oldest credit line on my credit report is over 12 years old.
- New Credit. This is 10% of your credit score. Every time you apply for new credit, the lender checks your credit score. This causes an "inquiry" on your credit report and can decrease your score 2-3 points. Multiple inquires in a short amount of time can also send your credit score into a downward spiral. Shopping for a mortgage or car loan is considered as one inquiry if done within a 30 day time period.
Using the above tips, you should see a significant increase in your credit score within 6-12 months, if not sooner. If you plan to make a major purchase within the next few months, start now to make sure you have the highest score you can. As seen in the example above, having a higher score can reduce the interest rate on your loan and save you money in the long run.
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Image Credit: Mene Tekel
Your site's slogan: "My goal is to be free of non-mortgage debt by May 2009. Can I do it?"
It's my goal as well and since they equal debt, for me that has meant eliminating credit cards. With the car paid off, and the debt of credit cards brought to zero - doesn't this bring ones fico to zero as well?
If so, how does this effect one's credit score, enployability, and/or ensurability?
Nice article - well written. Most people don't realise though that your credit history/ credit score is only one of five things you need to get a good rate on a loan/ mortgage. The other things are: ID, job, survey and deposit.
Great advice to follow. Definitely make sure to pay down credit card debt well before applying for a loan. I track my credit score with a service each month. One month I used a credit card for a large purchase and had my score drop significantly, even though I paid it off in full at the end of the month.
@Phil: Once you pay off debt, your credit score does not decrease to zero. You will maintain a good credit score as long as you do not close the accounts.
I still can't get over the photo that accompanies this post!