You try hard, but still have a mediocre credit score. You pay no attention and have a great one. Just how are credit scores calculated, anyway?
Good question – and it has a complicated answer.
This is a topic I tackled for the “How Credit Works” section at Self.inc. “How are credit scores calculated?” takes a deep and nerdy dive into the issue of credit scores.
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Every so often I do a “read me elsewhere” roundup of articles I’ve written. Lately a lot of the work I’ve done is either editing someone else’s site, doing non-bylined stuff or writing stuff that’s so ridiculously specialized that I wouldn’t bore my readers by sharing it.
The topic of how credit scores are calculated is one that I think can help a lot of people, though. No matter how unfair you think the credit scoring system is, the fact is that we are currently stuck with it. A smart consumer will learn to operate within its confines. That is, unless you like paying many tens of thousands of dollars in extra interest during your lifetime.
From “very poor” to “exceptional,” credit scores matter. They determine the kind of interest rate you’ll get on housing, vehicle and other loans. They might determine whether you get that loan at all, at least from a conventional lender – and the others can somehow get away with charging loan rates of up to 35.99 percent.
The best deals on credit cards generally require a score of at least 670. In most states a low credit score can affect your vehicle insurance rates and also determine whether you get that apartment you wanted.
Some money mavens swear that you don’t need credit. I absolutely disagree. How many folks can realistically hope to save enough money to buy a house for cash? Traveling without credit can be difficult – and risky, if you’re using a debit card. (In fact, debit cards in general are risky given that they’re attached to, you know, your bank account.)
Never would I suggest people use credit to spend like sailors on shore leave. Anyone who’s read me for a while knows I’m against mindless spending in general, and with credit card interest rates it can take no time at all to dig yourself into a hole so deep you can no longer see daylight.
However, the credit system is what we have. Work with it. Ignore it at your own peril.
Speaking of credit card debt…
Another piece I did for Self.inc is called “Should you consolidate your credit card debt? A complete guide.” You’ll learn about various ways to consolidate and pay off your obligations, and the pros and cons of each.
For example, some swear by the home equity loan because it will have a lower interest rate than the one you’re currently paying on your cards. However, you’ll also have to pay closing costs because this is a second mortgage. More to the point, what gives me the screaming fantods is the fact that you’re trading unsecured debt (credit cards) for secured debt – and that debt is secured by your home. If something goes wrong financially, you might no longer have a place to live.
A home equity loan for debt consolidation works for some people. It doesn’t work for others. Then again, all the options depend greatly on your personal circumstances. One potentially great solution is to move all your debt to a 0% balance transfer card. Not everyone can qualify for one of these, though. If you do get one and don’t pay it off during the grace period (generally within 12 to 18 months), you’re back on the hook for interest. Don’t forget the fee (usually about 3% of the debt balance) that you paid to get the card in the first place.
It’s another complicated topic with an “it depends“ set of answers. If you’re concerned about the level of consumer debt you’re carrying, or know someone who is, please read/share this piece.
Credit score updates
Your score can change regularly; at times, scores taken just an hour apart could be different. Once again: It’s complicated. In yet another piece for Self.inc, I tackled “How often does your credit score update?”
The reason your score bobs and weaves is that creditors report at different times. Suppose you charge a bunch of new furniture, on the same credit card that also provides your FICO score. When the bill arrives two weeks later, you’re surprised to see that your score didn’t change.
Wait a little longer. Generally speaking, creditors report every 30 to 45 days. Your next FICO score could look mighty different. Or maybe it won’t, if for example your credit utilization ratio was already low and your credit limit is fairly high.
Confused? Read the article – and again, share it with anyone you know who could benefit from learning more about that three-digit number that has such a big impact on our finances.
Rent to own…a home?
I wasn’t aware of this option until I started yet another Self.inc article, “Rent to own: The complete guide.”
Unlike a mortgage, which is a deal between you and the bank, a rent-to-own home is a contract between you and the buyer. The two of you negotiate either a lease option or a purchase option (there’s a big difference, which the article explains) and you pay the owner a fee each year that you live there. (The fee might be subtracted from the purchase price.)
This can be tricky, and unfortunately scammers are out there. Yet a legitimate agreement can benefit both parties.
What about other rent-to-own options, such as electronics, furniture or even cars? Generally speaking, they’re not a good idea. Yet for people who don’t make much, renting to own may feel like the least worst option, or even the only option. For example, the “tires and wheels” rent-to-own category has grown rapidly. You can’t get to work in a three-legged car.
Not-so-fun fact: An industry group reports that 41 percent of rent-to-own customers earn from under $15,000 to $23,999, and that 31 percent earn between $24,000 and $35,999.
The article explains the ins and outs of renting to own, and also offers possible ways to avoid the practice. If you know someone who’s thinking that renting to own a giant TV is a good idea, please share this piece.
Getting out of the hole
Not everyone had the luxury of saving for retirement. Of course, some people had it but thought they were “too young” to think about that kind of thing, or that surely they’d start saving next year.
What if “next year“ never happened? Or what if you were ready to save something but along came layoff, divorce or serious illness?
Right now, U.S. residents in the 56-to-74 age group carry:
- Average mortgage balance of $175,865
- Average auto loan balance of $18,759
- Average credit card debt of $7,041
- Average student loan debt of $34,957 (their own or someone else’s)
Fortunately, four in 10 members of this age group have at least $250,000 in retirement savings. However, almost one in five have less than $50,000 in retirement – and 7 percent have no retirement savings whatsoever.
I was asked to write a personal advice piece for NewRetirement.com, to help those who haven’t saved enough (or anything) in their 50s. “17 ways to dig yourself out of a financial hole (and build toward retirement)” is a wake-up call for those folks.
Not as in, “Wake up, stupid! You’re so screwed!” Instead, I said that my own midlife years were a bit, um, fraught, and that I in fact couldn’t see any kind of future for myself. But as longtime readers know, I got out of debt and started saving for the future – while continuing to enjoy the present.
My advice is both practical (e.g., debt payoff strategies) and personal (e.g., give if it’s really important to you – but that money has to come from somewhere else in your budget). The idea isn’t to shame people, but to get them to take charge of their lives. And, yeah, to wake up so they won’t be so screwed.
Know someone (not necessarily in their 50s) who’s in money trouble right now and/or not saving for later on? Send them the link.
Related reading:
- Credit score myths that will. not. die.
- The life I once led
- What’s the weirdest thing you ever charged?
- Surviving and thriving on $12k a year: The reboot
Something else you might run into: you are working hard to pay off credit card debt, but as you do, the cc company lowers your limit, looking like you continue to use a high percentage of your available credit, thereby keeping your credit score artifically low.
I have read of people’s credit limits being lowered recently. The same thing happened in the 2008 recession. It’s a difficult situation and yet another reason not to overspend if at all possible.
Of course, if you’re using the card to stay fed and keep the lights on during times of un- or underemployment, it’s not as though you’re spending for giggles ‘n’ grins.
Argh.
Thanks for another interesting article. I had a $2.43 (I transposed the amount on the check I wrote the company) snowball in to $70 in late charges. I settled the bill with the creditor, and wrote letters to each of the credit bureaus but the late charge remains. It has hurt my credit for several years.
My credit store is still high enough, and my husband’s was unaffected by my mistake. It’s a good idea to always check your credit score. If I hadn’t checked my score I would never have known about this mistake, and hit on my credit score.
Object lesson indeed.
“An industry group reports that 41 percent of rent-to-own customers earn under $24,000 per year and that 31 percent earn less than $36,000.”
That sounds mathematically impossible.
The 41 percent that earn under $24k/year obviously earn less than $36k/year.
Perhaps they left out a key word or two? E.g., an additional 31 percent earn less than $36,000?
The 41 percent number is correct, if a bit confusing: 13 percent earn less than $15,000 a year and 28 percent earn $35,999 or less.
I’ve rewritten it to make this clearer.
If you are worried about someone taking out a loan without your knowledge you can put a freeze on credit reporting. It is free. You just have to thaw it before you apply for a credit card or loan. Lots cheaper than Life Lock.
Here are some tips for increasing your credit score:
*Pay your bills on-time, every time. Make a spreadsheet listing all your bills, the amounts, and the due dates. Once you pay a bill, mark it off in the spreadsheet. I’ve never missed paying a bill in over 20 years by using this simple method.
*Don’t apply for a bunch of credit cards at the same time and don’t cancel several at the same time either. Credit card companies will interpret this as something drastic happening in your life and ding your credit score accordingly.
*Have a good mix of debt types (mortgage, car loan, credit card, etc.)
*Don’t sign up for a store credit card just to get a discount off your first purchase. Have only 2-3 credit cards to keep things simple.
*Never, ever get a cash advance on a credit card. The interest rates are insane.
Hope this helps!