You’re working a show this weekend and after load-in, during a bit of downtime, you spot an eye-catching deal on noise-canceling headphones—perfect for those long flights or bus rides between cities. Tempting, right? You buy them on impulse. But later, as the excitement settles, you start to wonder, “Will I be able to pay for them?” This scenario reminded me of a chat with one of my tour managers during Amazon Prime Day. He called, excitedly talking about his purchases, caught up in the thrill of the deals. When I casually asked, “Can you cover these purchases comfortably?”, his hesitant, “I don’t know” reflected a moment we’ve probably all experienced. It’s easy to get swept up and find ourselves navigating the tricky waters of credit without even realizing it.
Understanding Credit
Credit, in its simplest form, is the ability to borrow money or access goods and services now and pay for them later. Whether it’s for buying a home, a car, or an expensive piece of equipment, credit often makes these large purchases possible. However, banks and lenders need to assess our ability to repay these borrowed funds, and this is where our credit score comes into play.
A credit score is a numerical representation of your creditworthiness and your ability to repay debt. Did you know that you have multiple credit scores? These scores are derived from the information in your credit reports, which are compiled by the three main credit bureaus: Experian, Equifax, and TransUnion. The two most common models for calculating credit scores are FICO and VantageScore, with FICO being the most widely used by lenders.
Adding to the complexity, not all lenders report your payment history to all three credit bureaus. The credit score you check before applying for a loan may not be the same one that a lender uses, because not all credit scores are created from data from all three bureaus. So, which score is the most reliable?
The truth is, there isn’t a single “most reliable” score. Tip: Instead of trying to pin down one perfect score, it’s more productive to focus on the factors that affect your credit scores and work on trending your score up over time.
Navigating The Credit Landscape:
So, let’s dive into the factors that play a significant role in shaping your credit score.
- Paying your bills on time (35%): Keeping up with your bill payments is like giving your credit score a regular boost. Each on-time payment is a positive mark that builds up your financial reputation, and over time, your score. If you run into a rough patch and miss a payment, your score might dip, but getting back on schedule with your payments can help recover those points gradually.
- Credit usage (30%): Have you ever heard someone talking about keeping their credit utilization low? It’s a fancy term for a simple idea: Use only a small portion of your available credit. Ideally, you want to use less than 30% of your available credit. If you are considering applying for a loan, it’s a good idea to keep your credit utilization even lower, ideally under 10%.
- Credit History Length (15%): Lenders look at the age of your oldest and newest accounts, the average age of all your accounts, and how recently you’ve used them. Opening new accounts might lower your score temporarily because it reduces the average age of your accounts. However, you can offset this by keeping your credit utilization low. Tip: It’s beneficial to keep your oldest credit account open, even if you don’t use it much. This can help maintain the length of your credit history.
- Credit Mix (10%): Managing a variety of credit types, such as revolving accounts (like credit cards) and installment loans (like student loans), shows you can juggle different kinds of financial responsibilities. While diversifying your credit mix is helpful, remember it’s just a small part of your overall score—so there is no need to take on extra debt just for this purpose. Tip: Take a look at whose name is on your credit accounts. If you’re sharing finances with a spouse and all the credit is in their name, consider building credit in your name. It’s good for your financial health and can help in the future.
- Recent Credit (10%): Have you ever played the game where you apply for a credit card just to snag those 100,000 bonus miles after spending a certain amount? It feels fun, almost adventurous, like your next vacation is practically paid for. But here’s the catch: while signing up might feel like a win, it can temporarily dip your credit score. It may also encourage you to spend beyond what you would have, leading you to stretch your budget more than intended.
Imagine that on top of the vacation bug, you’re also looking to finance a new car and perhaps even eyeing a new home. Each application might seem like a step toward big dreams, but multiple applications paint a different picture to lenders. However, if you manage to keep all your big loan inquiries—like those for the car or home—within a 14-day period, credit bureaus see it as you shopping smart, not getting credit-happy. They count those inquiries as just one, softening the blow to your credit score.
Debunking Myths About Credit
While many of us are busy figuring out ways to improve our credit scores, it’s just as crucial to clear up some common misconceptions. Let’s tackle a few myths you might have thought were true. Understanding these can really change the way you manage your credit and might even make maintaining a good score a bit easier.
- Myth #1: Paying Off My Balance in Full Each Month Helps My Credit Utilization.
You might think that clearing your credit card balance every month means you’re all set, right? I actually did for a long time. However, the credit bureaus look at the balance on your statement closing date. So, even if you’re diligent about paying off the bill in full each month, if you consistently charge more than 30% of your available credit, it still looks like you’re using a significant portion of your credit limit. Quick Fix: Try making a payment just before your statement closes. This way, a lower balance gets reported, helping you keep that credit utilization in check.
- Myth #2: I Should Keep a Small Balance on My Credit Card.
This came up on my most recent trip to Nashville, and no, you do not need to keep a balance on your card. Keeping a balance just means you’re paying extra in interest. Always aim to pay off your credit card balance in full each month.
- Myth #3: Closing Old Credit Cards Boosts My Score.
Actually, it’s quite the opposite. Older accounts boost your credit history, which can help your score. Closing a card means you lose that credit limit, which can increase your credit utilization ratio. Tip: If you’re not using the card and it’s free, you might just want to cut it up but keep the account open. However, if it’s costing you a hefty annual fee and you’re not using the perks, then it might make sense to close it. Just try not to close any accounts when you’re about to apply for a loan.
- Myth #4: Checking My Credit Score Will Lower It.
Have you ever hesitated to check your credit score because you heard it might drop? Checking your own credit score is a soft inquiry and doesn’t affect your score. But beware of your favorite retail store’s pitch to save 20% by opening a store card—that’s a hard pull on your credit and can indeed ding your score. Store cards often have high interest rates, and if you don’t use them much, they could even be closed due to inactivity, forcing you to reapply later which may entail another hard pull. And, if you don’t charge often, it’s easy to forget a payment, sometimes wiping out the initial 20% savings you received.
If any of these myths have caught you off guard, you’re not alone. I recently led a workshop where the whole group had a lightbulb moment—and a good laugh—over the myths they’d believed all their lives.
Your Credit Report
We’ve touched on how your actions influence your credit score, but it’s crucial not to overlook the credit report itself. This document is the backbone of your credit score, containing all the vital data that shapes it. In the past, you could request a free credit report from each of the three bureaus once per year, but since the pandemic, the rules have changed. Now, you can request your reports once a week for free at www.annualcreditreport.com. While you probably won’t need to check weekly, having the option is beneficial. Tip: Download each report as a PDF so you can review it thoroughly at your convenience. Pay close attention to the details—accounts listed, any negative marks, soft and hard inquiries, and personal information. It’s essential to download reports from all three bureaus, as they might not all have the same information. If you spot any errors, make sure to report them to the bureau involved.
Freezing Your Credit
We’ve checked our credit scores and ensured everything in our annual reports is correct. We’re all set, right? Not quite. There’s one more protective measure to consider: freezing your credit. Before I started coaching three years ago with HerMoney and personal finance expert Jean Chatzky, whom I admire greatly, I hadn’t considered this step either. But here’s why I love it: freezing your credit is straightforward. Simply visit my website at www.lifesjam.com/resources and download the guide on How to Freeze Your Credit. You’ll create a login for each of the three major credit bureaus and then it’s as simple as clicking a “Freeze” button. When you need to lift the freeze, just log in and click “Unfreeze.” You can even set a future date for it to automatically refreeze. This setup not only protects you from identity theft but can also act as a safeguard against impulsive decisions, like applying for that store credit card on a whim. The primary time you might want to avoid having your credit frozen is when you’re applying for a loan. Otherwise, it’s a handy tool to have. And don’t forget, you can freeze your children’s credit too—there are a few extra steps for those under 18, but these are clearly outlined on the bureau websites.
Summary
In my experience working with people on their finances, credit usually comes up somewhere in the middle—it’s important, but it’s not everything. Try not to obsess over your credit score. It’s a useful tool that can help you save money and build wealth, but it doesn’t define who you are. My take? Build your credit before you think you’ll need it. It’s one less thing to worry about when you do.
Reach Rachael Bronstein at rachael@lifesjam.com
