Credit Scores: They Do Matter

A certain well-known (and often polarizing) financial expert insists that a credit score is unimportant, even insinuating that it’s inherently immoral. “The ‘I love debt’ score,” he calls it.

He suggests closing all credit lines and letting your score fall to zero. I choose to trust he has his own experiences informing this belief, but I also believe spreading this advice to a trusting public is downright irresponsible. The truth is a credit score is extremely important.

Companies use credit scores to decide whether to offer you a mortgage, credit card, auto loan, and other credit products. Scores are also used for screening to rent a home or apartment, to buy insurance, and even to gain access to home utilities.

Your credit score is lenders’ & approvers’ at-a-glance metric, driving decisions that directly affect your financial and personal well-being, like where you live and your access to electricity.

Your score directly affects the interest rate and credit limit you will receive from lenders. The better your score, the less a loan will cost you.

So not only do you need to have a credit score; you’ll need to care for it and keep it as healthy as possible.

Credit scores range from 300-850. Why aren’t they 0-100% like test grades in school? Who knows. But as with school, the higher the score the better. Good credit is between 670-799, and 800+ is considered excellent.

What Factors Influence Your Credit Score?

There are several factors considered in your score. Some have a high impact and some have a lower impact on your final number. Each is listed below in order of importance.

On-Time Payments (HIGH impact)

This is the measurement of how well you pay your credit bills on time. If you’re late making a credit payment, your percentage of on-time payments decreases and will decrease your score. And since this is one of the most influential metrics of your score, paying your credit cards & loans by the due date each month is imperative to improving and/or maintaining your score.

Credit Utilization (HIGH impact)

This is simply the percentage of your credit limit that you’re using. So if you have a credit card with a $10,000 limit and you have a $1,000 balance, you’re utilizing 10% of your available credit. It’s best to keep your total utilization under 30% at all times for a good score. But the lower the better.

Derogatory Marks (HIGH impact)

Derogatory marks are indications of poor debt choices. These include accounts in collection, liens, and bankruptcies. They show an escalation in collecting a debt from you.

Listen, sometimes these things happen and they’re beyond your control. I had a missed medical bill go to collections once, and it dinged my credit score hard. Try to keep these things from happening, of course, but don’t beat yourself up if they do.

No matter the reason, any negative marks will likely stay on your credit report for seven years or more unless you can have them removed.

Age of Credit (MEDIUM impact)

This is the average age of all your credit lines and loan accounts. This shows creditors how long you’ve been using credit, and more time equals more trustworthiness in the eyes of a creditor. If you close a line of credit that you’ve had for many years, your average credit age could decrease. When you open a brand new credit card, your average credit age will definitely decrease, so this is why it’s important not to go hog wild and open a bunch of new accounts in a short period because it will directly impact this average. It’s also important to note that your credit age takes precedence over number of accounts you have. Which brings us to…

Number of Credit Accounts (LOW impact)

This is the number of different credit cards or loans open in your name. In general, the more accounts you have the better. But keep in mind that there are some higher-impact factors influenced when opening more accounts. So if your number of accounts is lower, opening a bunch of new accounts in rapid succession will likely do more harm than good for your score, so stay informed and be strategic.

Credit Inquiries (LOW impact)

Credit Inquiries measure a count of all hard credit inquires placed on your credit report. When you authorize a lender to get your credit report it’s considered a hard inquiry. Each time you ask for credit you’ll have a hit to your credit score.

If you get your credit report yourself or have unauthorized credit pulls (the source of all the “congrats! You’ve been pre-approved!” junk mail we all get), those are called soft inquiries, and they do not affect your credit score.

This is the factor I find that people are often concerned most about (“credit hits”); however, it’s low impact and one hard inquiry will not tank your score. It takes about 5 hard inquiries in a short time to affect your score much.

All of these factors contribute to a healthy score.

Much like how grades and SAT scores in school shouldn’t be the only factors considered when judging someone’s aptitude, the fact is that they usually are. So rather than let grades fall away unattended in high school or college one should instead use the metric for their benefit. Our credit scores are similar. We may not like that a number defines our trustworthiness and financial acumen, but that does not mean that we should ignore it altogether.

If you take nothing else from this article, please know that worship of credit scores is not ideal or necessarily healthy, but caring for your score is just as important as caring for your budget. It is another important building block for your overall financial wellness.

Next week we’ll explore ways to improve your score considering each of these factors and more — no matter where you are starting on the scale.