When she read that I was talking about buying or building a house, Foundry reader Ethel mailed me and asked if she could write a guest post about an important elephant in the room when making a large purchase: your credit score. Ramit Sethi from I Will Teach You To Be Rich points out that a bad credit score will cost you tens of thousands of dollars over the course of even a modest mortgage.
Take it away, Ethel…
Why it’s Frugal to Build a Better Credit Score
A good credit score can make it easier to secure loans and get better interest rates, but what many don’t realize is that a bad credit score can hit your wallet in ways you are not aware of. Besides having to pay higher interest rates on loans and mortgages, a poor credit rating can cause denial of employment, higher insurance premiums, or paying a higher security deposit when renting a house or apartment. Cell phone companies may even require those with a low credit score to pay a security deposit of as much as four or five hundred dollars before they can open an account.
What is a Good Credit Score?
Most credit reporting agencies use what is known as the FICO (Fair Isaac Corporation) model or a version of it to calculate your credit score. Various factors such as your bill payment history, the types of credit you have, the length of your credit history, and recent borrowings are considered in its calculation. A “good” credit score, according to Experian, one of the major credit reporting bureaus in America, depends on the system used by your lender. Most credit scores fall in the range of 600 – 750, and the average score for the United States is around 720. Generally they say, a score of 700 or above suggests that you manage credit well.
How to Improve Your Credit Score
There are several steps you can take to improve your credit score if it’s on the low side. One of the most effective methods is to pay off any outstanding bills and continue to pay them on time in the future. Your history of paying bills makes up 35% of your credit score, so making timely payments can raise it quite quickly.
Another effective way to raise your credit score is through the responsible use of a credit card. If you charge only small amounts which you can pay off in full every month, your credit score will gradually rise. If you aren’t able to pay the full balance, maintaining one of less than 30% of your card’s limit is also effective. For instance, if you have a $1,000 limit on your credit card, make sure you keep the balance at around $300 or below. [ed: NEVER use a credit card if you can’t pay the balance in full each and every month.]
If you don’t qualify for a standard credit card, you can get a secured credit card. You simply deposit an amount of money with your bank, and they will issue you a card with a limit equal to the amount you deposit. You must follow the same practices as with a normal credit card, keeping your balance at below 30% of your limit, or paying it off in full every month when you can in order to increase your credit score.
Raising your credit score is really not that hard. It does require a focused plan and a bit of discipline, but it is well worth the effort it takes. Paying your bills and making loan payments on time can save you from costly penalties or late fees. For those seeking a mortgage, a healthy credit score can save you tens of thousands of dollars over the course of the loan. Why pay more of a security deposit than you need to? A little effort can go a long way, not only towards raising your credit score, but to raising the balance of your bank account as well.
Ethel Wilson is a financial and credit specialist with 12 years experience in the banking, credit scores, and financial industry. She has advised countless clients on how to improve their credit score rating. She now shares the best of her credit score rating information as a contributor and editor of creditscoreresource.com
Thanks, Ethel! One thing I’d add is to check all 3 credit scores yearly. The official website for checking your scores is annualcreditreport.com. Do NOT use the websites that you see advertised, even if they say “free” they are for-pay services. You can also get your credit score checked for free by 3rd party sites like creditkarma.com. They “guess” your score so it isn’t 100% accurate, but it’s close enough to monitor if you’ve been the victim of identity theft, between your yearly official credit check-ups.