Understanding your credit score

  
     
April 24, 2014

Since my oldest son is in college now, I plan to have “the talk” with him when he’s home from school this weekend for the Easter holiday. Yes, we’re going to talk about his credit score — and how it can either be his best friend or his worst enemy.

Like many Americans — especially younger Americans — I doubt he completely understands what a credit score is. And, like his grades in college, the higher the credit score, the better. A credit score is a mathematical algorithm of the information found in his credit report, which is used to determine his credit worthiness. Not only will a low credit score affect his ability to get a loan, it will also affect his ability to get a job, rent an apartment, get a cellphone, and even find affordable car insurance.

First, he needs to understand the elements that make up his credit score, so that he can set his priorities and make good choices, if he’s ever faced with the decision of either paying his bills or ordering pizza.

Timely payments: About 35 percent of his score is determined by whether or not he pays his bills on time. Even one late payment can bring down his credit score. It probably goes without saying, but always choose bills over pizza.

Utilization: Utilization means how much available credit he has versus how much he’s actually using, and this element makes up about 30 percent of his credit score. For example, if he has a credit card that has a $1,000 limit, and he has a $900 balance, his utilization rate is 90 percent, which is too high. Potential new lenders will see him as someone who’s stretched too thin financially to take on more debt. Experts say consumers should never use more than 50 percent of their available credit.

Type and length of credit: Believe it or not, if he has a variety of different types of credit, his credit score will be higher. Ideally, he would want to have a mortgage, car loan, credit cards, and student loans (all paid on time, of course), to show creditors that he has a well-balanced credit history. Conversely, someone with only a gas credit card, for example, has not demonstrated to creditors that he has the ability to pay different types of debt. Types of credit comprise about 10 percent of his credit score, and the length of time he’s had it (the longer the better) make up about 15 percent.

Frequency of credit inquiries: Ironically, the number of inquiries that credit bureaus have had for his credit score will affect his credit score, to the tune of about 10 percent. Too many inquiries in a short amount of time mean he’s applying for a lot of credit and could be a sign that he’s in financial trouble, which makes him a higher risk for new credit.

Maintaining a high credit score is crucial to future success for my son or anyone else. I hope he puts forth as much effort toward maintaining it as he does his academic grades — or more.