Understanding Your Credit Report
One of the most important tools in your financial tool box is your credit report! As a financial coach and CERTIFIED FINANCIAL PLANNER™, I recommend checking your credit report each year. In fact, I keep a copy of all my reports in my personal financial information binder. By doing this I can keep tabs on my credit and any account inquiries during the year.
"Credit Report." It's one of those things we hear about all the time. Maybe you don't know what a credit report is, or perhaps you know what it is, and you're still terrified of yours and what it might look like! Either way, there are plenty of people who experience overwhelming feelings of anxiety associated with credit reports and the like! Most of us know we should be thinking about our credit report, or at least considering it. Still, many of us feel a little behind when it comes to talking about what a credit report is and why it's important. Unfortunately, this is one of those things that is critically important to anyone's financial success but gets often overlooked in the education system.
I'm here to tell you - don't be nervous, be excited! Today is the day! You're going to learn what a credit report is, how it affects you, and what you can do to improve yours!
Why Credit is Important?
Credit is a metric that institutions who don't know you, like banks, can use to make decisions about whether or not to do business with you. For example, a bank or credit union may use your Credit Report to decide whether or not to give you a loan. They could also use it to determine your credit limit and interest rate for a credit card. Another example of someone using Credit to "get to know you" is an employer doing a credit check! If your Credit is terrible or has too many red flags, it could affect your hireability when applying for jobs.
A credit report is essentially a report card in terms of Credit. A credit bureau gathers details about your financial history. It uses that information to compile a report that includes personal information, financial information, and public records on an individual. There are three major credit bureaus in the United States: Equifax, Transunion, and Experian, each of which is obligated to provide at least one free credit report per year. (The reporting agencies are currently offering free credit reports until April 2021)
According to Investopedia, the five most common criteria used to calculate Credit are payment history, credit utilization, the average age of accounts, composition of credit accounts, and recent credit inquiries. Some of these factors affect your credit score more and for more extended amounts of time than others. Payment history, which usually accounts for about 35% of your credit score, refers to your record of making payments on your accounts promptly. Credit utilization is the difference in the amount of Credit you're allowed and the amount you're using; it consists of around 30% of your score. The average age of accounts is exactly what it sounds like, and it is 15% of your score. 10% of your score is your credit accounts' composition, which means what types of Credit (loans, credit card debt, mortgage, etc.) form the entirety of your accounts. How often and recently you make hard credit checks is last and composes about 10% of your overall score.
There are dos and don'ts for each credit criteria. Paying on time/early, using a smaller percentage of your credit allowance, having older credit accounts, having "good" debt (like a mortgage as opposed to maxed out credit cards), and not hard checking your credit score often are good practices that will bolster your credit score. Inversely, having a short credit history, making late payments, checking your credit score too often, having a lot of high-interest loans/debt, and using a large amount of your credit limit will hurt your score.
Having good Credit is all about developing and sticking to good financial habits. Suppose you're maxing your credit cards out and paying their minimums. In that case, you're setting yourself up for both bad Credit and bad financial habits. In many ways, your credit score and credit reports indicate how successfully you manage your money. Talking with a certified financial advisor or a financial planner is one way to find a clear path to improving your credit score.
What to do if Something Doesn't Look Right
Whether you think a financial institution or credit bureau has made a mistake or you think something more sinister is afoot, you should get a copy of your credit report. After you've done that, you need to identify any errors in the credit report, let the credit bureau that made a mistake know, and let the financial institution associated with the error know that there's been a mix-up.
Bad Credit isn't the End of the World
Work on improving your Credit; don't let it ruin your life. In most cases, you can improve your Credit within a matter of years. The key is to not panic. Take improving your credit score as a one day at a time challenge because that's what it is. Take the necessary steps to pay down credit cards (ideally to 20% or less utilization), make as few hard inquiries as possible, and make payments on time. It may feel like it will take forever and that you aren't doing anything. Still, by being responsible and taking it one day at a time, you're making slow incremental improvements to your credit score and report.
Is Your Credit too Negative?
If you feel utterly helpless and that there's no hope for you or your Credit, you need to get in touch with a financial planner or financial coach. We're here to help you out in situations exactly like this.
A CERTIFIED FINANCIAL PLANNER™ Can Help You Create a Plan to Improve Your Credit
As a CERTIFIED FINANCIAL PLANNER™, I've worked with clients to create plans, get out of debt, and raise credit scores. If you or a family member need some guidance in improving your credit score or checking your credit report, please call or email to schedule an appointment with me.
Until next time... this is Melissa Making Cents!
Melissa Anne Cox CERTIFIED FINANCIAL PLANNER™ is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.