Credit score tips and tricks…for everyone

Blog post #412

Your credit score is very important for your financial future, if you want to get a mortgage, lease an apartment, refinance an existing mortgage, get a credit card, a vehicle loan or almost any other kind of debt. In some states, your credit score can even impact your homeowners insurance rates.

This post can be helpful to you, regardless of your age, marital status or income. It may also be valuable to others you know, such as family members, and we encourage you to forward it and share it with others.

Everyone should have at least a few credit cards in their own name. Even if you are married, each spouse should have credit cards in their own name, so you can each establish and have your own credit history. This does not mean that you have a joint credit card account with American Express and each have a card with your name on it. This means each person in a marriage should have a few credit cards that each person has applied for in their own name. This is vital in case of divorce or death of one of the spouses. We highly recommend this as we repeatedly see spouses, particularly women, who have not established credit history in their own names.

Credit score basics: Credit scores are calculated and maintained by a few major organizations, based on data accumulated by a number of national organizations. FICO score is the most commonly used credit score, based on a company called Fair Isaac.

FICO scores are reported on various scales, with some that top at 850, and others that have 900 as a maximum score. The higher the score the better for you, in terms of likelihood of approval, lower interest rates and other fees.

Per experian.com, these are the 4 major FICO scores and their ranges:

  • FICO score 8: 300-850
  • FICO mortgage score: 300-850, and there are different models for each rating company, Experian, Equifax and TransUnion.
  • FICO Auto score: 250-900, used in auto financing
  • FICO Bankcard score: 250-900, used by credit card issuers

Per experian.com, the following scores and grade ranges, based on a grade scale of 300-850:

800-850 exceptional, 20%
740-799 very good, 25%
670-739 good, 21%
580-669 fair, 18%
300-579 risky or very poor, 16%

On an 850 point scale, the average American has 701 FICO score, per experian.com, on 9/17/19.

Obtaining your credit score: Many card companies and banks now provide free FICO or comparable credit scores to their banking and credit card customers, with your monthly statements or online. American Express, Capital One, Citi, Discover, Chase and many others provide this data for free. If you can get your credit score for free in this manner, which is usually updated monthly, there is no need to pay another company to obtain your credit score.

How is your credit score determined?

Credit scores are determined based on a calculation with the following weightings and factors.

35% payment history
30% amount you owe
15% length of credit history
10% new credit open
10% types of credit you have

Although these factors are well known, and more are details below, there is no clear information as to how an exact credit score is calculated. For example, there is no specific formula available to consumers that tell us how each specific score is calculated.

To try to understand how you can improve and then maintain your credit score, let’s review the factors and what impacts them.

35% payment history: If you have late payments, this factor is going to be negatively affected. This is the most important factor in determining your FICO score.

It is vital that you make your payments on time to have a good or excellent credit score.This includes all kinds of obligations, including credit cards, vehicle loans, student loans, mortgage, and medical bills. Any company that you owe money to could report a payment late to a national credit bureau, which can have a negative impact for years (reduce your credit score).

The best way to have a good payment history is to make all your payments on time. Even if you can only afford to make a minimum payment on a credit card, if you make them on time every month, you will get a good score in this category. The best way to make sure you make your payments on time every month is to set up automatic payments. If you are having financial issues and can only afford to be making a minimum payment, you should seek assistance regarding this situation, which is beyond the scope of this blog post.

30% amount you owe: It is not just what you owe, but how you owe it. What does that mean?

Credit bureaus and credit card companies evaluate how much outstanding debt you have. They look at your total debt, which is your outstanding credit limits and loan obligations. It is good to have some debt, but too much will be a negative.

It is recommended that you keep your overall credit card utilization rate, for all credit cards, at below 30%. This means that your outstanding usage should be less than 30% of the total of your credit limits. If you have charged or have a balance outstanding of $5,000 and the total credit limit of your credit cards is $10,000, you have a 50% utilization rate, which is not good. If you have the same $5,000 balance outstanding, and your credit cards limits total $40,000, your utilization rate is 12.5%, which is excellent. Remember, the data may be reported to credit reporting bureaus at a different time than your billing cycle, so this could be impacted even if you pay off your balance every month.

But the factor that many people are not aware of is what is called your card utilization rate. Credit scores are also impacted by the outstanding balance of each individual credit card, as a percentage of the total credit limit of the respective credit card. You should limit the charges per month or outstanding balance of any individual credit card to 30% or less of that card’s credit limit. For example, if you have a $3,000 outstanding balance on a credit card with a $4,000 credit limit, that is a 75% utilization rate. This is viewed as a major negative. The credit card companies report this information to the credit bureaus at any time during a month, so even if you pay off your balance in full every month, this is still negative.

You should strive to keep your usage of each individual credit card below 30% at any point in a month. Thus, if your credit limit on a card is $4,000, you should try not to charge more than $1,000 on that card in a month. If you have a credit card with a $10,000 credit limit, you should not charge more than $2-3,000 on it in any month. This is why it is important to have a reasonable number of credit cards and at times, you may need to spread your spending across multiple cards.

If you only have two or three credit cards, rarely use one and then charge most of your spending on one card, you are likely using up a lot of your credit limit, thus causing your utilization rate to be very high. This will cause your credit score to go down, but can be improved over time, by a better use of your credit cards (use more of them, but not charging more than 30% of each card’s credit limit).

If you close a credit card, you are reducing your overall credit limit, which could be a negative for your overall utilization rate, as well as impact your credit length history, which is another factor.

This is why over time, you should obtain a reasonable number of credit cards, keep them open for a long time and not close them unless there is a specific reason to do so, and have a appropriate amount of credit limits on both a per card basis, as well as on an overall basis, so you can be below the 30% utilization rate both on a per card and overall standpoint.

15% length of credit history: Your credit history is built up over time. This is why it is important to establish credit when you are young, develop good habits, and keep credit cards open for a long time, even if you rarely use them. It is best to use a number of credit cards at least once or twice a year, even if you only use a few the majority of the time. If you set up a utility or automatic bill to be paid, and then set that credit to be paid automatically, you will improve this score over time.  In general, if you don’t have an exceptional credit score, don’t close a credit card, even if you rarely or hardly ever use the credit card.

10% new credit open: Applying for a loan or credit card triggers a process known as a hard inquiry, in which the lender requests your credit score for use in its lending decision. Hard inquiries typically lower your credit score by a few points, but as long as you continue to pay your bills on time, scores typically rebound within a few months.

10% types of credit you have: Credit scores reflect your total outstanding debt and the types of credit you use. The FICO® Score tends to favor a variety of loan types, including both installment credit (loans with fixed monthly payments) and revolving credit (like credit cards, with variable payments and the ability to carry a balance). Credit mix can influence up to 10% of your FICO® Score.

Changes in your score: It is not uncommon for your credit score to vary every month, due to changes in your outstanding balances, as well as if you applied for a new loan or credit card. However, your credit score should not move dramatically from month to month, unless something caused it to change significantly, such as a missed payment or payments, or multiple credit requests.

Strategies for those in their 20s: For younger people, particularly those in their 20s, establishing credit and a good credit score is even more important. Since 2010, you cannot get a credit card on your own if you don’t have an income until age 21.

Parents can, and should, have their children become authorized users of one or two credit cards that are actually in the parents’ name, if they feel their children are financially responsible. This could be done for high schoolers, and especially college age students, who could then pay the balances each month. The parents, as the account holders, remain legally responsible for all charges, but the children benefit from being authorized users and begin to build credit history. This will be valuable after they turn 21 and can apply for credit on their own.

Chase is now offering credit cards to college age students, with very low credit limits, which can further help students to establish a credit history, and hopefully good habits. This program is only available to Chase customers. However, it has an interest rate of 16.99%, so we don’t recommend this credit card unless you are sure it will be paid off every month. If college aged students choose to apply for this credit card, you could earn a credit limit increase after making 5 monthly payments on time within 10 months from account opening when meeting the credit criteria. You will not have to pay an annual fee and you will have access to Credit JourneySM. With Credit Journey SM you will have unlimited access to your credit score.

Once someone turns 21, they should develop a strategy of gradually applying for credit cards over a period of years, such as a new card every 6 months. If they are able to pay the balance off each month, they should focus on getting a card that provides a good cash back for most purchases (like 1.5%) from a major financial institution, such as Chase, Capital One, Bank of America or Discover. They should be strategic and selective, as discussed above, as applying for too many cards in a short period of time will result in a reduced credit score and possible rejections.

The illogic of credit scores: Your income, assets, length of employment have nothing to do with your credit score. Even though they would appear to be key to one’s ability to pay off debt, which is the purpose and supposed predictive value of a credit score, they are not any part of the calculation. To us, this seems illogical, but it is reality.

  • For example, a 30 year old earning $60,000, with minimal savings or investments, with 5-7 credit cards that are all 3-6 years old, each with low utilization rates and no late payments, and a car loan, may have an excellent credit score.
  • Someone who is 60, who earns $200,000 a year, but has only two credit cards, one which they never use and the other is used a lot, a mortgage but no car loan and substantial investments, may have a much lower credit score than the 30 year old above, due to how credit scores are determined.
  • This 60 year old may not have as high of a credit score, but the credit score could be raised if the suggestions above were followed.

There are also other applications available to you to view your credit scores. One of those options is Credit Karma. Through Credit Karma you will be able to view your credit score and reports. Credit Karma does not provide you with a FICO credit score. However, it uses Transunion and Equifax to pull your credit scores, but you will need create an account first through creditkarma.com before accessing your credit score. Credit Karma also monitors your credit reports and will send you an alert via the email on file when there is a change on your reports. You could get additional useful information such as thoughts on how you can improve and what affects your scores. Your credit report and credit score should always be readily accessible through logging into creditkarma.com or available through the Credit Karma app.

As your overall investment strategy is important to your current lifestyle or future retirement plans, your credit score is also an important part of your financial well-being. If you work to improve your credit score this should help you to qualify for loans when you need them. Most importantly, using your credit in a responsible, consistent manner and earning good credit scores could help build wealth and allow you to do business with companies. If you don’t know how credit works, this could get you in trouble.

If you have any questions, need direction with your credit, or would like to discuss this further, please contact our office.

For additional information concerning your annual credit report or travel rewards and credit cards, please see the links below to past blog posts that we believe could be beneficial to you.

Sources:

How a credit card can save lots on trip insurance costs

My wife and I just booked a trip to Spain for September. As this will be my first trip to Europe, it has been quite a learning experience already.

While this blog generally focuses on investing and financial topics, we know that our clients love to travel. We hope you find this informative and helpful.

I’ve learned that many travel experts (as well as my parents!!) highly recommend trip insurance, and significant medical evacuation coverage in particular.

Medical evacuation coverage is recommended in case you are seriously injured while traveling and need to be taken by ambulance, plane, helicopter or other form of transportation to a medical facility, if you then later need to be transported to a better hospital or eventually to a hospital back in the US. Coverage is recommended for $500,000.

I have a premium credit card, which unbeknownst to me, provides very good, but not optimal travel insurance coverage. As I’ll explain, my costly credit card actually saved me more than $1,100 on the travel insurance. If I was older, the savings would have been even greater!

Comprehensive trip insurance for our trip purchased as a separate insurance policy would have cost about $1,200. This would cover trip interruption and cancellation (which would have reimbursed us for the non-refundable tour costs if we couldn’t go because of a medical emergency between the time we booked the tour and the departure date). This would apply to an emergency to me, my wife, any of our immediate family members, such as parents, children or siblings, and even a broader range of relatives. The policy also provides up to $500,000 of medical evacuation costs and other coverages. The policy cost is based on your age and cost of your trip.

My Chase Sapphire Reserve credit card costs $450 per year, but gives $300 in travel credits annually, so the net cost is really only $150. One of the card’s features is a range of trip insurance coverages, including up to $20,000 of trip interruption coverage, similar to what I described in the preceding paragraph. However, they only provide $100,000 of emergency medical evacuation coverage, which is considered inadequate.

Thus, the credit card’s trip insurance coverage was good, but I still needed another policy for emergency medical evacuation.

Through my travel agent for this trip, I contacted an insurance company that provides a range of trip insurance policies. The trip insurance company is a subsidiary of Berkshire Hathaway, which I viewed as quite positive. For only $92, we were able to purchase a policy that has very minimal coverages in most areas, but has $500,000 of medical evacuation coverage and $50,000 of medical benefits. This policy will be the primary insurance and the credit card coverage will be supplemental on top of these benefits.

I recommend that you review your credit cards if you are planning a major trip in the future, especially a cruise, pre-paid tour or trip outside of the US, where your costs are paid up-front and usually non-refundable.

You may find that it is advantageous to obtain a premium credit card with travel insurance coverages and use that credit card to pay for such a trip. That is key, as you must charge the respective trip’s cost on that credit card for their insurance coverage to apply. Even though you may have a hard time paying a $400+ annual credit card fee, it may actually save you many times that amount versus the cost of obtaining full, comprehensive trip insurance on its own. Plus, these premium credit cards have many other benefits, depending on your traveling and other features. See my prior blog post on credit card and travel benefits, 12 Travel and Credit Card Tips for Greater Value and Enjoyment Part 1 and Part 2.

While I’m not advocating any specific credit cards, it appears that the Citi Prestige and Chase Sapphire Reserve credit cards provide broad trip insurance benefits. There may be others as well. Surprisingly, American Express’ Platinum card does not offer trip insurance coverage for interruption, cancellation or medical emergencies, such as medical evacuations.

Please view this as general advice, as trip insurance policies have many details and conditions. You need to pay for the trip/tour/cruise on the card that provides the insurance benefits. You should review your own personal situation, as well as the details of any insurance policy provided via a credit card benefit or a stand-alone trip insurance policy.

If you purchase a separate trip insurance policy, whether for comprehensive coverage or specifically to get evacuation coverage for a trip outside of the US, it needs to be purchased promptly after you book/pay for the travel. In my case, the insurance policy needed to be obtained within 21 days of my initial trip deposit or payment.

For the insurance coverage provided as a credit card benefit, you don’t need to do anything at the time of booking. You only need to contact them when you have an issue that would warrant an insurance claim.

I would also recommend that you bring copies of any of these policies and the respective contact information with you on the trip, as you would need to contact them in case of an issue. It would also be advisable to give the information to a close family member who is not traveling with you. For the medical evacuation coverage, the company needs to be informed immediately and they must approve most expenses in advance.

Now that I’ve learned about this, I will soon be purchasing an additional set of supplemental trip insurance policies, as I’m planning to take my two sons to Greece around Thanksgiving to visit my daughter, who will be studying abroad this fall as part of her junior year in college.

As we often tell our clients, it is important to save and invest, but it is also important to have great experiences and be able to travel while you are healthy and able to do it. I’m thankful and looking forward to be able to go on both of these trips.

Hopefully none of these insurance policies will be needed, but I do feel more secure knowing that I will have them.

We can’t control the future. But we can help you plan to minimize your risks and help you feel more secure.