When we think about strategies for improving our financial situation, there are some pretty standard things that come to mind. Most of them revolve around saving money, which usually requires us to think about ways to cut our spending. This leads us to strategies like eating out less, renegotiating a cable bill, or figuring out the cheapest way to buy diapers. But we often ignore one of the simplest and least understood ways of saving a lot of money: improving our credit history.
You’ve probably heard of a credit report. You may have even pulled yours before. But by and large, credit reports are largely misunderstood and ignored as a tool for saving money. In this post, I’d like to talk about what’s on your credit report and why it’s important. In a subsequent post, I’ll talk about ways you can improve your credit history, which can save you a lot of money over your lifetime.
Your credit history basically consists of two things: a report that details the specific items that constitute your credit history, and a single score, called the FICO score, that summarizes your credit history along a spectrum from good to bad. Both the score and the details behind the score are important.
Your report will have your identifying information and then will show details on things like credit cards, student loans, auto loans and mortgages. It will show your initial balance, remaining balance, current payment and payment history, even for closed accounts. It will also include any bills that you’ve had go into collections, and any public records like bankruptcies, civil judgments, tax liens and foreclosures. It will also include a list of any recent inquiries into your report, meaning any people who have looked at your credit report.
Your FICO score is a number ranging from 300-850 that serves as a quick summary of your credit-worthiness. It’s based on a number of factors, including your history of making payments on time, how much of your available credit you’re using, how long you’ve had credit, and how many different types of credit you’ve had.
So why is this important? There are a number of reasons. If you’re applying for a job or attempting to rent a new apartment, your employer/landlord will often pull your credit report as a way of verifying that you are someone that can be trusted. If they don’t see any history, or they see recent negative history, they will may be inclined to go in a different direction. Being turned down in either one of these circumstances can have a definite negative impact on your financial situation.
Your history and score will also impact both your ability to get a loan or open a credit card, and the interest they will charge you. You may not immediately be concerned about getting a loan, but the chances are very high that at some point you’ll at least want a mortgage. Even if you already have a mortgage, improving your score could give you the chance to refinance at a lower rate. The interest rate you’re charged will have a dramatic affect on how much money you pay over the life of your loan.
For example, I checked the site http://www.myfico.com/myfico/creditcentral/loanrates.aspx today, 2/14/2013, and saw that for a 30 year fixed mortgage, the average rate charged to someone in the highest credit score range (760-850) is 3.27%. For someone in the next highest range (700-759), it’s 3.49%. And for someone in the lowest range at which you could still qualify for a mortgage (620-629), it’s 4.86%. Let’s say you took out a $200,000 mortgage at those terms and look at both your monthly payment and the total interest paid over the life of the loan in each case:
As you can see, there’s a big difference both in the monthly payment and in the interest paid when your credit score gets low. Think about what you could do with an extra $180 per month, or an extra $65,000 that didn’t go towards interest? This real money you can save by making sure you have good credit. If you want to play around with the numbers yourself, you can use the calculator at http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx.
By now, it should be pretty clear why your credit history and score are important. In my next post, I’ll talk about some different ways you can improve your credit.