Why Good Credit is a Financial Resource to You and Growing Wealth

Many people understand having good credit is important, but don't understand the variables that impact it. This article will cover credit score in detail and how it works to help achieve long-term financial goals. First, let's see how the relationship of a credit score impacts your lifetime payment on a mortgage loan.

The pictures below illustrates the mortgage rate change with two different levels of credit scores. I used 20% down as this avoids PMI fees, the State of Kansas, and a 30-year fixed rate as this tends to be the most common loan term. This will all vary by state, down payment, and loan amounts but the concept is the same.

Now I'll illustrate the lifetime cost of the loan with an interest rate of 7.061% and 6.611%, respectively(current rates may be different). With the same terms of 30-year fixed, $300,000 loan amount, and Kansas. This doesn't include other expenses associated with buying a home such as property taxes, insurance, HOA, ect.

What should be gleaned from this example is that by building and having good credit, you could save yourself roughly $30,000 over the lifetime of a loan. Building and having good credit is also something you, yourself are in control of. Although over a 30-year period saving $1,000 a year may not seem like much, when you combine it with other areas where you can save money based on things in your control it all adds up to growing wealth.

Credit Report vs Credit Score

Two different things, a credit report is a complete report of an individual's personal finances. This can be your bill-paying history, the status of your credit accounts, if you pay on time, how much you owe and to whom, and how much you have paid. Credit reports should be reviewed at least once annually.

Next, your credit score is the number(typically ranging from 300-850) that is used for a lender such as a credit card company, mortgage broker, or car loan. The two types of credit scores: FICO and Vantage, both competing companies. Lenders will typically use FICO but it is good to know about both. FICO is only calculated once you have 6 months of credit history while your VantageScore can be calculated 1-2 months after an account is opened. Below is a picture sourced from Forbes in 2021 of a general ranking of scores:

What Impacts Credit Scores?

Multiple factors can effect your credit score. Some of the most common are paying bills on time for mortgages, credit cards, any loans, or utility bills. One term to know is your credit utilization rate. Your credit utilization rate is your current credit balance relative to your credit limit. Having a high credit utilization rate can negatively impact your credit score. In fact, this is one of the most powerful pieces impacting your credit score. A general rule of thumb is to keep your credit utilization rate as low as possible and specifically less than 30%. For example, if your credit limit is $10,000 you want to keep your credit balance at less than $3,000 at all times.

Another thing that can impact your credit score is the length of time you have credit. Example: You opened your first credit card in 2015 and then opened a new credit card in 2018. Now you currently only use the credit card you opened in 2018 because it has better benefits/rewards. It wouldn't be recommended to close the credit card you opened in 2015 because it will negatively impact your credit score shortening your length of credit by 3 years.

Most important factors impacting credit score, sourced from LendingTree:

1. On-time bill payments(Also avoids late fees/interest)
2. Credit utilization rate
3. Length you have been in the credit game
4. New credit(Too many hard inquiries in a short time)
5. Credit Mix(Credit cards, student loans, mortgage ect.)

Soft vs Hard Inquiry

Whenever you apply for a credit card, loan, or job your credit score will want to be known. There are two different types of ways your credit score will be pulled: soft or hard inquiry.

Soft inquiries typically happen when you apply for a new job, your credit score can tell an employer a lot more about a person and the employer may use that as a reason to hire one person over another. Another soft inquiry can be when credit card companies try to get you to apply for their credit card, the issuer will check to see if you qualify for certain credit card offers before sending anything out. (If you frequently get mail to sign up for a credit card they have already considered you most likely eligible via a soft inquiry). Soft inquiries do not effect your credit score and are only visible to you when you view your credit reports. Checking your own credit score generally doesn't impact your score and is considered a soft check. You can do this through major credit bureaus: Equifax, Transunion, or Experian.

Hard inquiries occur when a financial institution such as a lender or credit card issuer checks your credit when making a lending decision. These usually occur when you submit an application for a mortgage, loan, or credit card, and you typically must authorize them. Hard credit checks generally stay on your credit reports for a couple of years and may only lower your score by a couple of points or even have a negligible effect. The damage done usually disappears or decreases before the inquiry drops off your credit report for good.

You may want to consider this if you plan to apply for multiple credit cards and a loan within a few months span. Multiple hard inquiries can cause issuers and lenders to consider you high-risk and suggest you are short on cash or have a lot of incoming debt. It is a good idea to strategically think about this if you plan to get a loan in the near future and new credit cards.

Conclusion

To sum it up, credit scores are vital to your financial life. Good credit scores can provide access to better interest rates, larger loans, and more favorable terms. Conversely, a poor credit score can limit your opportunities and lead to higher costs in the long run. It is important to understand how credit scores work and to take steps to maintain a good score, such as paying bills on time, keeping balances low, and monitoring credit reports regularly. By doing so, you can enjoy the benefits of a strong credit score and achieve your financial goals more effectively!

The information provided in this publication is for general information only and is not intended to provide specific recommendations. Some of the information provided above is obtained from publicly available sources and is believed to be reliable, but no representation or warranty is made as to its accuracy or completeness.