Last December the New York Post reported that in a study of 2000 Americans, 13% had no idea what their current credit score is, 76% did not understand the ramifications associated with a bad credit score and 8% really did not even know what ‘credit’ was. Being a recent college graduate, who is also studying the importance of credit in a Financial Paraplanner course, I am realizing credit is a continuous strategy and battle in life. As a refresher, today we will discuss what credit is, the importance of it, and its affects.
“Credit is the ability to borrow money or access goods or services with the understanding that you'll pay later” says Experian. Creditors grant people credit entrusting they will pay it back. The more you prove that you can pay back the money you borrowed, and any other charges applied, you are said to be more ‘credit worthy,’ also known as having ‘good credit.’
How is credit determined? By Credit Reports analyzed by three credit bureaus; Transunion, Equifax and Experian. Information in credit reports are: the amount of any loans taken out and how much you have paid back, whether monthly payments are made on time, late or missed, the number of credit cards you have including balances, and severe financial setbacks like foreclosures, car repossessions and bankruptcies. Then, a credit scoring model calculates your credit score preforming a statistical analysis creating a 3 digit number, from 300-800, that is easy to interpret. 300-579 is very poor, 580-669 is fair, 670-739 is good, 740-799 is very good and 800-850 is exceptional. You can check yours at creditkarma.com.
Why is credit important? Credit is one of the things the US economy is built on! According to the market realist, credit leads to an increase in spending which leads to higher GDP (gross domestic product) and therefore faster productivity growth. Banks are direct beneficiaries of credit because their primary business is to provide loans in return for interest payments, which is a great way to build credit if paid off on time.
Having good credit can offer great benefits like easier approval for renting and buying houses, better car insurance rates, better chance for loan approval and more negotiation power. Realtors, insurance agencies and bankers will always look at your credit score to determine the ‘price’ it would be to work with you, and a trustworthy credit score will have them on your side from the start! With good credit, you could gain leverage to negotiate different interest rates and or other terms, something that likely would never budge with poor credit. With poor credit, interest rates skyrocket, loan applications may not be approved, insurance premiums increase and you could get denied a cell phone contract and employment, as most employers and cell phone services monitor credit of applicants.
When a creditor checks your credit, there are two types of ways, a ‘soft credit inquiry’ or a ‘hard credit inquiry.’ Soft inquires usually occur without you even knowing. For example, if you have ever received a credit card via mail, the company probably checked if you were qualified enough to include you on the mailing list. Hard inquiries affect your credit score and therefore require your consent before doing so. A hard inquiry is triggered when you actually apply for credit, like for a mortgage, credit card, any type of loan, etc. This inquiry becomes a part of your credit score, meaning it could shave off a few points, and it is there forever for you and others to see. So, always think twice about applying for credit that would create a hard inquiry pull as it may bring your credit score down.
Credit is known to be something that is not exceptionally hard to build, but is terrifyingly hard to recover once it is damaged. Credit can control more aspects of our life than we could ever imagine, like purchasing a home, buying into a cell phone policy or looking for a job. Let’s keep working on ourselves, and our overall economy, by always striving for great credit!