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WHAT I’M THINKING ABOUT:
Managing Your Credit Score
In the premise of a memorable Black Mirror episode, every person has a “rating.” On an Amazon-like scale of 1 to 5 stars, your rating is based on how your fellow citizens score you after an interaction. So if you run into an old fling at the grocery store and share a delightful conversation and look good to boot, you’d probably get 5 stars, which would incrementally improve your overall rating. And this rating, in turn, determines everything from merchant privileges and discounts to your network of friends — in other words, it’s your all-in-one socioeconomic score.
Fortunately we’re not there (yet), but the next closest thing is your credit score. Designed to help lenders gauge your creditworthiness, your credit score is also used to evaluate you in all sorts of contexts like insurance underwriting, background checks by landlords, and even job applications. Yikes!
While a poor credit score can limit your options, a good credit score provides opportunities to invest in the things you love — your family, work, hobbies, and dreams. So let’s start by breaking down the essential need-to-know facts about credit reports and scores, and then we’ll look at healthy habits for managing and improving your credit.
YOUR CREDIT REPORT
What is it: A history of all your credit accounts and your record of paying them off. Things like student loans, credit cards, car loans, and mortgages show up on it.
Every relationship with a lender — past and present — is captured in your credit report. Details like when the account was opened, credit limit, payment history, current standing (past due, closed, good standing, etc.) all contribute to your score. Personal information such as history of addresses and phone numbers are also included. Additionally, your report will indicate who has requested your report, which happens when you apply for a new line of credit or submit a rental application, and sometimes when you apply for a job.
Federal law entitles everyone to one free credit report (which doesn't include a score) every twelve months from each of the three major credit reporting agencies — Equifax, Experian, and TransUnion. A lot of websites claim to offer free credit reports, but you can trust Annual Credit Report actually does.
YOUR CREDIT SCORE
What is it: Your credit report boiled down to a number, on a range of 300 to 850. The higher your score, the more creditworthy potential lenders will judge you to be. You’ll hear credit scores referred to as FICO scores because the Fair Isaac Corporation (“FICO”) developed the calculation model. (FICO is the most widely used score, but you may also see VantageScore out there.)
Each of the three credit reporting agencies gives you a number based on the information in your report. (Yes, each agency scores you independently.) A higher score makes you more attractive to lenders like banks and credit card companies. A higher score also means you’ll qualify for lower interest rates. Your score constantly changes as new information hits (or falls off) your report.
Here’s a general guideline of how lenders interpret your credit score:
800 - 850: Excellent
740 - 799: Very good
670 - 739: Good
580 - 669: Fair
300 - 579: Poor
For reference, around 700 is the average FICO score in the United States.
There are five key components of your credit behaviors that determine your score, which we’ll break down in turn:
Payment history: 35%
Amount owed: 30%
Length of credit history: 15%
Types of credit in use: 10%
New credit: 10%
Payment history (35%): Your track record of making or missing debt payments is the most important piece of your credit score. This section of your report gets pretty detailed, showing the length of time you’ve been delinquent, past bankruptcies, and collections (from the last 7 years).
Amount owed (30%): Referred to as credit utilization, this measures how much of the credit made available to you you’re currently using. So, for example, if you’ve charged $3k to a credit card with a $10k credit limit, your credit utilization would be 30%. A higher credit utilization will negatively impact your score, as it can indicate an over-dependence on credit.
Length of credit history (15%): The average age of each line of credit determines your length of credit history. Longer credit history is better. Opening new cards will decrease your average credit length, as will closing old cards.
Types of credit in use (10%): There are lots of types of credit from mortgages, student loans, car loans and credit cards. Showing a variety of lines of credit in good standing improves your score. (But don’t take on unnecessary debt just to add a new type of credit.)
New credit (10%): Anytime you apply for a new line of credit, your score dips for a period of time. Opening multiple lines of credit in a short period of time will have an even greater negative impact on your score.
Keep in mind that a single action will often impact several of the five components. For example, when you open and start using a new credit card, that impacts your credit utilization, length of credit history, and new credit.
HEALTHY CREDIT HABITS
Whether you’re looking to maintain or improve your credit, the following practices will serve you well.
1) Routinely review your credit report. Get in the habit of reviewing your report to make sure everything is accurate — ideally once a quarter, but at the absolute minimum once a year. Often an error on your credit report will be the first indication that your identity has been stolen.
2) Always correct errors, and quickly. Report any errors on your credit report directly to that credit reporting agency. For example, if you’re looking at your TransUnion report, you’ll report errors to TransUnion. The easiest way to do this is online, but you can also report inaccuracies by phone or mail. Keeping your report accurate will serve you well when your report and score get requested by a bank (or anyone else).
3) Never miss a payment. This is one of the most important things you can do to improve your credit score. Missing a payment on a credit card or other loan impacts your score very negatively, so set up automatic payments or calendar alerts. If you can’t make an upcoming payment, it’s always best to be proactive and reach out to your creditors before you miss a payment. Ask what options they can offer you such as a lower payment, extension on the due date, partial payment, and even a lower interest rate. You need to be polite and persistent but this often will get you results. I’ve seen it happen.
4) Be thoughtful about opening and closing lines of credit. Don’t open a retail card at the cash register just because you’re going to get a huge discount on all of those back-to-school clothes. Having a ton of retail cards doesn’t show a great credit mix, and opening and closing cards impulsively is not an attractive quality to creditors. Every time you open a new card the length of your credit history shortens, which lowers your score. Also, accounts stay on your report for many years after you close them. In short, be thoughtful about when you open and close lines of credit. Also, some retail cards have poor online platforms that don’t allow automated monthly payments which makes it too easy to miss a payment.
5) Frequency and amount matter. It’s good to use your credit frequently, but the amount of credit you use each month also impacts your score. For example, if your Visa card has a limit of $10k, charging close to that $10k each month is a red flag to creditors, signaling to them (even if you never miss a payment) that you might be having cash flow problems and potentially need more credit. A good rule of thumb is to not use more than 30% of your available credit (so, $300 in our example) at any point during the billing cycle. A quick fix if you have a big month of charges is to make an extra payment in the middle of a billing cycle. If you are routinely coming close to maxing out your credit on a particular account, consider requesting an increase in your credit limit. This can generally be done online and is a relatively quick and painless process (though this might temporarily lower your score).
6) Don’t let others use your credit. Do not let a family member or friend open up a line of credit in your name, and be extremely cautious when signing as a co-signer on a loan or adding an authorized user to a line of credit. You are fully responsible for the balance owed and the payment history as a co-signor, and you’re fully responsible for paying off all charges made by an authorized user.
REPAIRING YOUR CREDIT
Improving a poor credit score can be a bit of a catch-22. You need a line of credit to establish payment history and improve your score, but you can’t qualify for a line of credit because your score is too low (or you have no credit at all). Fortunately, you have some options.
A good one (beyond following the usual healthy habits above) is a secured credit card. This works like a regular credit card, except you put down a deposit as security (for example, you deposit $500 which then becomes your credit limit). And so banks are willing to issue you the credit card despite a poor credit history. If you’re disciplined about making timely payments every month on your balance, then you’ll start establishing a good payment history and your score will go up. (See here for a list of recommended secured credit cards.) Be sure to keep your credit utilization to around 30% or lower. A simple yet effective approach is to only use the card for small monthly subscriptions (like Netflix and Spotify) so your credit utilization is low, and then set up automatic monthly payments for the full statement balance.
Whether you’re building credit for the first time or repairing poor credit, it’s going to take time — think in terms of months and years rather than days and weeks. Keep the long view and be patient. I’ve seen plenty of people recover from credit that was tanked by bankruptcy or collections and progressed to better days. Your credit does not define you and, in time, this season will be history.
MANAGING CREDIT DURING THE PANDEMIC
The COVID-19 pandemic has added financial stress to the lives of many (if not most) Americans, rendering debts and other financial obligations all the more difficult to meet. The recent CARES Act, passed by Congress in response to the pandemic, does provide some protection when it comes to credit.
If you’re able to work out repayment accommodations with your lender — which many lenders are being more flexible about during the pandemic — then the lender must report the account as current (meaning you’ve paid on time) so long as the account was in good standing at the time of accommodation. So don’t be shy about trying to work out accommodations with your lender, as it won’t negatively impact your credit score if you keep your end of the agreement. (This requirement is in effect until 120 days after the COVID-19 national emergency has ended.)
While many lenders are making accommodations for COVID-19-related hardships right now, reports have indicated that many borrowers are having trouble accessing these programs. Inconsistent application of these programs, inaccurate reporting to credit bureaus, and difficulties accessing representatives are just a few of the snags people are finding. As always, be vigilant and advocate for yourself. Keep excellent notes and records of these conversations and changes to your accounts so you can clean up errors on your report.
What I’m Reading
Many minorities avoid seeking credit due to generations of discrimination
By Lori Teresa Yearwood, CNBC
According to a 2015 CFPB study, about 20% of adult Americans have credit histories that are either non-existent or insufficient to generate a score, and a disproportionate number of these are people of color. This article provides some helpful insight into why some people of color have avoided traditional lines of credit:
Decades of discrimination by the federal government and America’s financial institutions has induced an almost trauma-like response, causing many people of color, particularly African-Americans, to adopt self-protective behavior not unlike a post-traumatic stress reaction. The paradox: This defensive behavior, where the cause of injury is avoided, often distances people of color from the very credit-granting institutions they need to thrive.
How to Get Your Money to Those Who Need It More Than You
By Ron Lieber, The New York Times
As the economic toll of the COVID-19 pandemic mounts, this article highlights several organizations that connect donors with people in need, facilitating cash transfers to vetted beneficiaries. And research on direct cash transfers (performed on recipients outside of the U.S.) appears to support the efficacy of this model:
Recipients tend not to spend more on “temptation goods” like tobacco and alcohol but do increase what they lay out for more and better food. Many people also invest in infrastructure upgrades, like replacing thatch roofs with iron.
So let’s all up our generosity game and start putting our money to work.
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