What’s a three digit number that will affect your finances for the rest of your life? Your credit score. Some people believe that having a good credit score is important when you’re buying a new car or want to get a store credit card. But, your credit score is not used just to approve or deny you for loans, it can also affect the amount you’ll pay in interest. Maintaining good credit is essential to having a financially stable life, even in retirement.
What is a credit score?
The grades you earn in high school determine the colleges you’re accepted to. Similarly, your credit score is a “grade” that determines if you’ll be approved for more loans and what rate you’ll receive. There are three main credit bureaus (Equifax, Experian, and TransUnion) that come up with your score. Each bureau uses the same five factors to calculate your score.
Payment History – By far the most important factor in determining your credit score, payment history looks at all of your loans and how often you pay them on time, how often you’re 30+ days late making a payment, any bankruptcies and delinquent accounts you may have.
Amounts Owed – The amount of money you owe lenders is used to indicate if your spending habits are sustainable. For example, if you have three credit cards, and all of them are nearly maxed out, the credit bureaus may consider that to be unsustainable, and it will lower your score.
Length of Credit History – Your score is also affected by how long you’ve had credit. Having more years of information (good information) will increase your credit score.
New Accounts & Inquires – Another factor that goes into your credit score is the number of credit accounts you’ve opened or applied for in recent months. Creditors who see that you’ve recently applied for multiple store credit accounts may be concerned that you’re a high-risk borrower.
Credit Mix – Your credit mix shows the different types of credit accounts you have. Common credit types are auto loans, personal loans, credit cards and mortgages.
So what’s a good score? Scores typically ranges from 300 to 850, with higher scores being better. Every lender has a slightly different model of what scores are poor, fair, good and excellent, but the chart below gives you a general idea.
Those with scores in the “Bad” and “Very Bad” tiers risk not being approved for loans that they need, and if approved they will pay a much higher interest rate. For example, if a person is approved for a $25,000 car loan at a 3% interest rate, for 60-months they will pay around $449 monthly. That same $25,000 car and 60-month term at a 12% interest rate makes the payments $556 per month. At the end of the five years, the person with poor credit will have paid over $6,000 more for the same car.
Credit Score and Retirement
Paying $6,000 more for the same car is a huge difference. But the disadvantages of having a lower credit score don’t stop there. People with poor credit will also pay more in credit card rates, and personal loans. Housing will cost more as well - mortgage interest rates will be higher, and renters could face higher prices and be required to put a larger deposit down. You could also end up paying more for cell phone and cable plans, as well as insurance. Even potential employers look at your credit! If you want a new position that requires a certain level of clearance, having bad credit could nix your chances.
Over your lifetime, having a lower credit score can cost you thousands of dollars. This will trickle over into your retirement, and can significantly affect the way you’ll live in your golden years. Consider the money you could save with a higher score – that money could go towards retirement savings. In our car loan example, you’d save over $6,000 with a higher credit score. If you invested that $6,000, assuming a 5% rate of return, you’d have over $25,000 at the end of 30 years.
Simply put, having a higher credit score will greatly impact your life, now and in retirement. Raising your credit score can save you thousands of dollars during your lifetime.
Action Steps:
Find out your current credit score. Visit your credit union or an online website such as Credit Karma to find out your score for free.
Use a tool such as Online Bill Pay to ensure your payments are made on time. Remember payment history is the largest factor in determining credit score.
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular individual or circumstance. This article is not intended to be a client-specific analysis or recommendation. Do not use this article as the sole basis for any financial decisions. Consider all relevant information. Information should not be considered as tax or legal advice. You should consult with your tax advisor and/or attorney regarding your individual circumstances.
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