Oct. 8, 2021

What is your credit score telling you?

What is your credit score telling you?

💯 💯 💯 "a credit score is a numerical measurement of risk that a borrower poses to a lender, basically, it's an indication of how likely you are to repay a loan on time. The higher number that you have, the better position you're in, it's like aceing the test of financial responsibility"


EP 41:  What is the mystery behind that 3 digit number that seemingly determines the rest of your life?  We've heard about credit scores, we may even know that more is better.  But what makes up a credit score and how does it impact us?  In this episode, we break down the 5 factors the create a total credit score and why its important to maintain solid credit.  

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Transcript

Michael Der  0:02  
You're listening to Artrepreneurs, a podcast that inspires photographers and visual artists to live their best creative lives. My name is Michael Der and I am a full time photographer with nearly 10 years of experience in the freelancing world. And I'm sitting down with an amazing community of visual artists to talk about process, business, and the lessons that have helped them grow. So let's get to it. Artrepreneurs starts right now. 

Hey, what's up everybody? Welcome back to another fabulous day here at Artrepreneurs thrilled to have you tuning in and supporting this show that today we're going to talk about that seemingly arbitrary number that controls so much of your life and the opportunities afforded to you down the road, whether it's the car, the home, or even the gear that you buy, many of the decisions that you're going to make many of the purchases that you're going to make down the road can be impacted by a singular pesky three digit number. So buckle in, folks, we're diving into the wonderful world of credit scores. So we're going to be addressing what a credit score is how a credit score rating is calculated, what doors our score will either open or close for us, and ultimately simple ways to improve our score with better financial habits. 

So what is a credit score? Well, a credit score is a numerical measurement of risk that a borrower poses to a lender, basically, it's an indication of how likely you are to repay a loan on time, the higher number that you have, the better position you're in, it's like a sing the test of financial responsibility, or at least that's what they supposedly say more on that later. The lower your number is, on the other hand, the lesser position you're in, you are viewed as having done not as well on the financial responsibility exam. And as a result, you're not going to be provided the same benefits, offers and opportunities. So think of it like an LSAT score. The higher you score, the higher your leverage, the lower you score, the lower your leverage scores range from 300 to 850. And those who don't have enough credit history, like high school graduates, for instance, or people who pay cash their whole lives may simply not register score at all. So think of a credit score as a portrait of someone's credit history information like how long you've engaged with credit how diversified your credit is, and how fast you pay that credit offer all factors in determining the rating of your credit. So here's the official breakdown of how your credit scores are calculated. 

One payment history 35% payment history is the most important factor that goes into a consumers credit score. It reflects whether or not you can make payments on time to each of your accounts, tardy payments equal lower scores.  

Two; credit utilization 30%. So much of your credit score is going to be based on the total amount of outstanding debt like student loans, credit cards and mortgages. In short, your credit utilization is the percentage of total credit used in comparison with the total credit available. So for example, to clarify that because it's a little bit complicated if you had let's say a $5,000 limit on just one credit card and you owe 20 $500 to that account, your utilization rate or the amount owed is 50%. So the higher your utilization, the riskier your lenders will assume you to be 

number three, credit age 15%. So your credit age or your length of credit history is basically an indication of how long you've had credit and how old each of your accounts are. Now this is where time comes into play, the longer you've engaged with credit, the more benefits you're going to receive. And this is why young adults won't typically have high credit scores because they simply don't have as many years engaging with credit. 

Number four credit mix 10%. So a borrower's credit mix is the combination of credit that he or she uses. It includes credit cards, auto loans, student loans, and mortgages. Basically, maintaining a mix of credit demonstrates that you can handle multiple types of loans. 

Number five new credit 10%. So this illustrates how many times you've applied for new credit in the last few months or years. Now what's tricky about new credit is that it is important to increase your credit mix. But by doing so in a short period of time, you may actually lower the average age of your accounts which can hurt your FICO scores in the long run. So it's a very fine balance of opening new lines of credit, but not all at once. So now that you have a rough idea of what your score consists of, you might be asking yourself why is any of this important? How is it relevant to me? Well, let's revisit what I mentioned earlier in the episode your credit score is sort of like taking an essay t test that rating whatever that number is, is telling new creditors how likely or unlikely it is that you will repay your debts. The higher your score, the more benefits you're gonna receive because you're deemed as credible and trustworthy. The lower your credit score, the less runway you'll get. So let's use this as an example. Let's say if you're applying for a new credit card because you want to receive higher rewards and signup bonuses. A healthy credit score is going to improve your chances of receiving that credit card while also giving you a higher credit limit, which is simply the maximum amount of credit that a lender is going to give you. So let's use a couple different examples here to illustrate this. Let's say Frank is going to apply for a new credit card but he's got a credit score of 555 50 on the scale is considered poor credit. So the lender is going to be more likely to offer Frank a very basic credit card that offers no rewards, no signup bonuses and maybe a maximum credit limit love let's say $1,000. On top of that he

may have to pay an annual fee for the card or a higher interest rate because the credit history is basically stating to the creditor that he is less likely to pay back his debts. Sally on the other hand has an 800 credit score and so she's gonna be offered greater benefits because she has a stronger credit history. So she can choose from a variety of cards that offer cash back on purchases like 5% on travel 3% on groceries and maybe 2% on all other purchases, and she can choose which signup bonuses appeal to her most like a $500 sign up bonus, or maybe even a 15 $100 sign up bonus, when you spend X amount in the first three months, she's also going to have access to significantly higher credit limits. So while Frank is maxing out at let's say $1,000 maybe Sally maxes out at 15. 

This access is going to allow greater opportunities for you as a creative to front production costs to get jobs done. It's one of the critical aspects of being a freelancer in the first place. If a client asks you to fly out to California to do a job on net 60 terms, what that's effectively telling you is that you need to front flight, hotel food and rental car expenses two months before getting paid. So your job is to be able to get that job done, which you can't do if you have really poor credit. 

Now it's not just about the credit card approval or the lower interest rates or the higher credit limits that are going to be the only benefits to having good scores. It also helps for the largest purchases that you're going to make in your life, which tend to be around home and automotive. For instance, getting an apartment can be notoriously difficult if you have poor credit. And when it comes to home purchasing having an excellent credit score versus having let's say an average credit score can ultimately translate to you receiving better loans that could save you 1000s upon 1000s of dollars over the lifetime cost of the loan. So here are a couple stats from the folks at nerd wallet that sums up how much actually you may be costing yourself with lesser credit scores. They state that someone with FICO scores in the 620 range would pay $65,000 more on a $200,000 mortgage than someone with a score of 760. And a 15 year home equity loan of $50,000 would cost a low score $22,500 more than someone with high scores. That's just incredible. A mere 100 point difference in credit scores could cost you a down payment on a house or a college tuition or a brand new car. And speaking of car loans can be equally as bad they stayed on a five year $30,000 Auto Loan the borrower with low scores would pay about $5,100 more. And if that weren't good enough, car insurance companies oftentimes penalize people who have low credit scores with higher insurance premiums. 

And so if you happen to have a low credit score, folks don't take this personally, you can build this back up rather quickly with a few basic practices. And here are some of my personal favorites. 

Number one, make consistent on time payments. Now if you're going to engage with debt prioritize paying off said that it's as simple as that now if you're in a fair amount of it, I would suggest paying twice a term to accelerate killing it off. But at the very least, automate all your credit card and loan payments for the minimum just so you never accidentally miss a payment. Remember, 35% of what actually influences your credit score is how punctual you are 

number two, pay more than the minimum. Now I just told you to automate minimum payments and here I am telling you to pay more than the minimum. So what's going on? Well, automating the minimums is effectively the minimum, it's covering your assets, the least you can do it's a safety precaution, but it's never going to accelerate your debt killing and credit score raising stature. If you only pay the minimum, you're going to be in debt for a lot longer because only a small percentage of the minimum payment is applied to the credit cards principal, the remainder takes care of the accrued interest and fees. So here's a stat from experian.com. If your credit card has a 21% interest rate and a $4,000 balance, paying the minimum of 1% plus interest each month will keep you in debt for 257 months, folks, I did the math that's 21 years. And oh by the way, you're gonna spend $6,374.64 in interest, bringing that total cost to pay to more than $10,000 for that $4,000 purchase. So if you are paying the minimum payments, and it's $105 pay 115 always pay more than the minimum. 

Number three, don't max out your credit cards. So remember that 30% of your credit score is based on your credit utilization, whatever your credit limit is, try keeping your utilization rate to around 20% or under. So if you have a $10,000 credit limit, don't let your balances go over $2,000. The lower your utilization, the better. 

Number four, keep your accounts open. So remember that 15% of your credit score is based on the longevity of your credit age. So even if you don't use a card anymore, like that old Banana Republic card that you applied for when you were in college, trying to save 30% on a sweater, keep it open. 

And number five minimize your discretionary expenses. So the fastest way to improving your credit score is to clear off all your debts and maintain a good pattern of timely payments. This can be accelerated, the less you spend on impulse purchases and retail therapy. If you focus on essentials and killing off debt, you'll increase your score quickly. Now folks, the FICO score is not an almighty DD to pay all your time and attention to nor is it the only indication of a good financial practice. You could actually have a credit score of zero because you elected to pay for everything in cash and never rely on using debt that would actually make you incredibly financially disciplined even though your score might shut a lot of doors on you. The point of this episode is to get you to ask yourself whether you have any bad financial habits Now, that may end up costing you down the road late payments, minimum payments, high utilization rates, too many hard inquiries,

they can end up costing you 1000s and 1000s of dollars on big purchases like homes, cars and equipment can also hurt your smaller purchases like cell phone plans or car insurance. So what can you do today to improve your chances for when you do want to find out that new camera to Buy that new car or to bid on that new home. You see, this doesn't just apply to your photography career, it's about your life. And I believe you can support your personal and your professional lives a little bit better just by knowing how the game is played. So I hope this episode gives you a little bit of food for thought folks, thanks for tuning in and supporting the show. As always, remember we are on Artrepreneurspod on Instagram. I'm out of here for now folks, have a great night everyone and catch you next week. 

Hey everybody, this is Michael Der thank you so much for making it all the way to the end of the episode. I hope you'll follow tag and engage with us on our Instagram account at Artrepreneurspod. We've also launched our website Artrepreneurspod.com. It is the central hub where you can sign up for our newsletter, read our blog posts, send us voicemails, and even access discounts from our amazing affiliates. It's also the perfect spot to shout out Artrepreneurs with what would be an immensely appreciated five star rating and review. And if you're feeling extra generous, you can even make a small donation that's really going to help accelerate the growth of this podcast. But no matter what you do, folks, I just want to say thank you so much for supporting this program. There are a lot of great photography podcasts out there and I am just grateful to have gained your trust even for a moment. Take care everyone. See you next week.

Transcribed by https://otter.ai