January is National Financial Wellness Month. It’s a great opportunity to do some assessing of our financial well being. It’s also an opportunity to think about how well we’re modeling and training the young people in our lives—our children, students, mentees, etc.
Here’s a good example. Can we be trusted to repay a debt? I hope the answer is a resounding “Yes!”
That’s what we want lending institutions to answer when we apply for a loan or home mortgage. They’re making a bet on us to repay our loans with interest on time, all the time. But, in order for them to conclude that we’re worth the risk, they’ll need to analyze our financial condition. In that evaluation process, one of the key measures they consider is our credit rating. It’s their way of getting independent advice on our creditworthiness.
Most young adults don’t think about this when they’re starting out, but it’s an important principle to instill at a young age—and to be reminded of throughout life. Do you know what it takes to have a good credit rating?
The most commonly used credit measure is your FICO score. Scores from 680-850 are considered good by lenders. Your keys to a favorable credit rating include:
- Modest debt relative to your assets and income
- Reputation for paying your bills fully and on time
- Making regular deposits into your savings and investment accounts
- Having a modest number of credit cards and preferably with low or zero outstanding balances
- Paying off debt rather than replacing it with other debt
- Not bouncing checks
- Having a positive and growing net worth
When you have a good credit rating, you’ll receive better access to loans, larger available credit lines, and lower interest rates. It also affects your insurance rates and whether or not a landlord wants to take a risk on leasing a house or apartment to you. That’s why achieving a favorable credit rating should be a priority.
What if your credit rating isn’t so hot? You can turn it around. The sooner you start building—or repairing and RE-building, the better. It generally takes seven years for negative items to drop off your credit reports.
One thing to note if you are rebuilding your credit is that simply closing your revolving accounts to improve your credit score won’t necessarily work. Closing credit accounts not only lowers the number of open revolving accounts (which generally will improve credit scores), but also decreases the total amount of available credit. That results in a higher “utilization rate,” also called the balance-to-limit ratio, which will actually lower your credit score! So, though it seems counter intuitive, just closing accounts is not the answer; rather, you want to pay them off and then wait patiently. When repairing bad credit, TIME is one of your greatest allies, along with PATIENCE and PRUDENCE.
How would a financial institution assess you as a credit risk? If the answer is “good,” then well done! If the answer is “not good,” what are the primary drivers? What specific steps can you take today that will turn it around?