Credit Score Primer

Knowing what makes up your credit score is important for more than just applying for credit cards.

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No matter what some people say, having good credit and keeping an eye on your credit score is important. Even if you are planning to buy your car in cash, never want to own a home, and buy everything with your debit card or cash, it’s still something you shouldn’t neglect!

Like it or not, your credit score is often times what defines you to many types of organizations. When you sign up for electrical service, the electric company will often pull your credit to see if you need to put money down to start service.

Same thing for cell phones and insurance. I actually had to reject people from signing up for phone services when I worked at RadioShack because their credit was so bad!

Having good credit isn’t a necessity, but there’s no denying that in today’s world, it simply makes things easier.

It’s a lot easier to buy a home with good credit, unless you save up money to pay cash. It’s true – you can request manual underwriting without a credit check when you buy a home. But it’s a more complicated process, and not all underwriters will be happy to do so.

Do You Know Your Score?

Quick, off the top of your head: give me a rough estimate of your credit score.

If you were able to provide one – awesome. But the sad truth is that, despite being so integral to the world we live in today, nearly a third of Americans don’t have any idea what their credit score is.

What Makes Up Your Credit Score?

So many people don’t know what factors make up your credit score! Thirty percent – isn’t that nuts?! Even if you have a general idea, chances are you may not know how important each factor is. Here’s what makes up your credit score.

On-time Payments – 35%

Your payment history is the biggest single indicator of your ability to repay a debt. This shouldn’t be surprising. It also means that making sure you don’t have late payments is very important.

If you miss a payment, it’ll have a big impact on your score – particularly the later it is.

Credit Utilization and Available Credit – 30%

Are you the type of person who maxes out your cards? Bad news for your credit! Lenders want to see people who use their credit wisely.

I am for about a 5% utilization at any given time. That means that, if I have $50,000 in available credit, I’m using about $2500.

Average Account Age – 15%

The average age – not just the length of your credit history – of your accounts is also important. The longer you’ve had credit established, the better. I’ve heard of some parents putting their babies as Authorized Users on their credit cards to establish their credit history super early!

If you’ve had accounts open for a long period of time and have a good track record, the data is easier to trust.

Since this is an average, opening new accounts would potentially have a negative impact on this portion. That impact will be minimized over time.

Types of Credit Available – 10%

Lenders like to see a variety of credit available. Credit cards are one type, but others include car loans, student loans, and mortgages.

These types of debts behave differently, and lenders want to see people who are responsible handling multiple types of debt.

Inquiries – 10%

The last contributing piece is the number of hard inquiries you’ve had in the past two years. A hard inquiry occurs when a potential lender, landlord, etc. request a copy of your credit score/report.

They’re important to watch out for, because the more you have, the more likely it is that you’ve been looking to get credit cards or a loan. Lenders sometimes see this as a bad thing – perhaps you’ve applied for a car loan but weren’t able to get one for some reason. Therefore, they like to see as few of these as possible.

The good news is these fall off after two years and are only a small percentage of what makes up your score.

Why Should You Care About a Good Credit Score?

We’ve already established that, quite frankly, life is easier when you have good credit. You’re more likely to get better rates on things that you may want to finance, like a home.

I think everyone should consider paying cash for a car. If you can get a loan for less than something like 2%, though, it may make sense to borrow money and invest what you’d have spent. Of course, your investments could go down, so depending on your risk tolerance this may not be what you want to do.

Credit Sesame To The Rescue

Thankfully, getting a ballpark estimate of your credit scores is easier today than it’s ever been. It still baffles me in this day and age that we don’t have full access any time we want to the exact score used by lenders.

Sure, we have access to our credit reports, but that’s only once a year and does not include our score. Until that changes, companies like Credit Sesame can help us get a ballpark figure of where we stand.

Credit Sesame is a service that lets you sign up and keep an eye on your credit report and credit score from the three major credit bureaus. They’ll update your information every 7 days when you log in. I get in a habit of checking it each week.

It was particularly helpful when we were applying for mortgages. We were able to keep an eye on our credit, and had a good idea of our scores – in the high 700’s/low 800’s. The actual scores we got back were a little bit different, but Credit Sesame got us a really good ballpark amount.

Credit Sesame will let you see if you have any late payments. Sometimes banks get things wrong, and it’s possible to have a late payment on your report even if you paid on time! Checking this to make sure your payment history accurately reflects ACTUAL history is a huge value add.

Best of all, it’s totally free.

How’s It Free?

Typically if any company doesn’t charge you to use the product, then you are the product. Credit Sesame isn’t really an exception here, and they’re up-front about that.

They essentially act as an affiliate company, directing people to banks and other financial service providers. If people sign up for one of their recommended products, they get a referral fee. They don’t sell your data or anything – they just rely on these referral systems to help fund their operation.

Monetizing their business this way lets them keep the service free to consumers. If you want to read more information on that, they have a quick blurb on it here.

Better To Know Than Not

Whenever I ask people if they know their score, I’m confused when they say they either don’t know or don’t care. I just don’t get it! Even if you NEVER plan on taking out a loan, what happens if someone fraudulently takes one out in your name? What happens if that goes to collections and suddenly you need to handle the situation?

True story: I studied abroad in London back in 2007. One of the people I became friends with, Gabe, learned upon returning to the US that someone had fraudulently taken out a mortgage a few months prior in his name.

It was a nightmare for him to clean up, and could have been taken care of a lot quicker if he’d been keeping an eye on this. From then forward, I knew that it was better to know – even if you think your credit score might suck – than to not know.

That’s not a call I’d want to have. Being knowledgeable is always better than not. Do yourself a favor, and even if you’re never going to take a loan or let another company pull your credit, at least keep an eye on it for your own sake.

Better safe than sorry.

Question:

Do you use Credit Sesame or another similar service (like Credit Karma)?

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4 Comments

  1. Having good credit is really important. I got my first “me” credit card while I was in college. A $500 limit non-rewards credit card. I didn’t use it enough, and my credit score was 739 when I needed to get a car. Of course, I only qualified the the best rates from my CU with a 740 credit score, so I lost out on a 1.49% rate, and ended up with a 2.89% rate. Not terrible, but it cost me an extra $1,000 on my car loan.

    Moral of the story is even if you don’t want credit, get a CC, buy a pack of gum a month, and you’ll be in good shape.

    1. A thousand bucks is still enough to make a difference! Crazy how something so simple as what you use to pay for stuff can make such an impact.

  2. I agree with the above commenter. Buy something small, and pay it off every month to build credit.

    I have a future post related to how my husband and I had different views in terms of credit. I gave him guidance in understanding that having credit is an important tool. It’s all about building financial responsibility and one of those ways to do it is through establishing credit.

    I use both Credit Sesame and Credit Karma. I have a lot of tools I use redundantly! Nice article.

    1. Yeah I use both also. I like each of them, and both give me relatively accurate score estimates.

      I think credit sometimes gets a bad reputation amongst some folks like Dave Ramsey but really if you’re responsible with it, it makes life a bit less of a hassle.

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