Do you know how credit works? Or that it takes on a variety of forms, including credit cards, mortgages, student loans and car loans? Do you know when it makes sense to utilize credit? While many people understand what credit is, fewer people understand how credit worthiness and interest rates are determined.
Using credit may be appropriate or inappropriate, depending on the situation, but credit is generally appropriate for big ticket items. In most cases, people don’t have enough cash saved up to purchase a house without a mortgage loan. The same could be true for purchasing a new car.
On the other hand, credit may be inappropriate for day-to-day short-term variable expenses, such as gas and groceries, especially if you don’t pay your credit card bill in full each month. With an average credit card interest rate of 14%*, you’ll end up spending more if you use your credit card rather than cash, check or debit.
Eventually, all your uses of credit are compiled into a credit report. A credit report includes a list of opened and closed accounts, loans and when you paid them off, your record of on-time payments and your outstanding balances. If you have ever been sued or filed for bankruptcy, expect to see these on your credit report, too.
You are legally entitled to a free annual credit report from each of the three credit bureaus: Equifax, Experian and TransUnion. To be on the safe side, consider pulling one every few months or so to monitor your credit and make sure there haven’t been unauthorized inquiries or accounts opened by someone else. Do not respond to pop-up ads or emails offering free credit reports. They are likely scams.
Check your credit reports at annualcreditreport.com or order them by calling 1-877-322-8228.
Keep in mind, however, that your credit score is not included in the report – but it is calculated based on the data from your report. A credit score is a number that quantifies your projected liability to lenders. That number can affect many aspects of your financial life. There are a few ways to check your credit score:
- It may be located on your credit card, financial institution or loan statement.
- You can purchase it from one of the three credit bureaus or other providers like FICO.
- You can use a credit score service or free credit scoring site like creditkarma.com.
FICO is the most widely used credit scoring company. The credit score it generates – called a FICO score – ranges between 300 and 850. A higher score can help you secure lower interest rates when applying for credit cards or loans. According to credit.com, a score above 750 is considered excellent, scores from 749 to 700 are good, scores between 699 and 650 are fair, scores from 649 to 600 are poor, and scores below 600 are bad. A poor or bad score may result in higher interest rates or trouble qualifying for a loan.
How can you improve your FICO score?
- Always pay your bills on time. Nothing helps bolster your score more than timely payments.
- Keep the amount of credit you use below 30% of your total credit line. The ideal amount is below 10% of your available credit line.
- The longer your credit history the better. Keeping older accounts open with minimal use is one way to do that.
- Limit credit applications and inquiries. Too many in a short period of time could lower your score.
- A mix of credit is better than having just one type of credit. The mix may include things such as student loans, car loans, mortgages and credit cards.
To learn more, talk to a financial advisor with Waddell & Reed about your spending, budgeting and overall saving strategy.
This information is provided for informational and educational purposes only and may include references to concepts that have legal, accounting and tax implications. It is not to be construed as legal, accounting or tax advice, and is provided as general information to assist in understanding the issues discussed. Waddell & Reed does not provide tax advice. Waddell & Reed believes the information has been obtained from sources considered to be reliable, but does not guarantee the accuracy of the information provided.