Financial Literacy Month: How Your Credit Impacts Your Life
This post is sponsored by Lexington Law.
When it comes to personal finance, one thing always rings true: having control over your money gives you the power of choice.
While it might seem like you have all the time in the world to worry about your finances, don’t let that keep you from making money moves that will help secure your financial future. It’s never too late to start making positive financial decisions. And if you’re in your twenties, now is the time to begin laying the groundwork for your future!
When it comes down to it, good credit = freedom. Our credit scores impact our lives more than you might think.
What Is a Credit Score?
Your credit score is a “magic number” of sorts that lenders use to evaluate your financial trustworthiness. There are five factors that make up your FICO credit score:
- Payment history — 35%
- Utilization ratio — 30%
- Length of credit history — 15%
- New credit or inquiries (this hurts!) — 10%
- Types of credit/Credit Mix — 10%
Credit scores range from 300-850 and is calculated using various factors on your credit report, which is a record of your credit history.
This number can impact your life in a variety of ways, some even unexpectedly!
How Your Credit Impacts Your Life
A low or poor credit score and history can…
1. Give You High Interest Rates
From your mortgage to your car loan to your credit card, a low credit score means a higher interest rate. A lower credit score indicates that you are not as trustworthy as a borrower as someone with a high credit score. Lenders can’t be sure that you’ll pay them back so you’re a bigger liability to loan to.
Now, your interest rates for various loans do not have a direct impact on your credit score. However, having a higher interest rate means you’re paying more money out of pocket over time for the same service or item someone with a higher credit score is paying. So not only are you paying more, lenders are also profiting off of your low credit score.
High interest rates can also mean that your balances will increase month to month, especially if you only pay the minimum. If your balance is high and over the recommended 30% utilization ratio, your credit score could drop even further leaving you with even less options in the future.
2. Give You High Car Insurance Premiums
Yup, you’re reading that right. Having a poor credit score can cost you more when it comes to your car insurance premium.
Insurance companies use a myriad of factors when calculating your premium for coverage, and many of them use your credit score as one of those factors. It’s been correlated that drivers with lower credit scores files more claims. So insurance companies will charge you more to begin with because you are a higher risk to insure.
3. Keep You From Renting or Buying Where You Want
When you’re applying to rent or buy a home, lenders and landlords are looking at your credit score to determine trustworthiness. They’re also looking at your rent-to-income ratio. To really secure your chances, your annual income should be 40x the monthly rent at a minimum.
Those two are the major factors that come into play when it comes to a potential landlord. They want to know that you can make the payment (based on your rent-to-income ratio) and they want to know that you’re reliable (based on your credit score). A lower credit score can knock you out of the running for an apartment you really want, even if you can prove that you have the income.
4. Keep Your Credit Limits Low
Requesting an increase in your credit limit is one way to decrease your utilization ratio but it could backfire if you’re not careful!
Asking for a credit limit increase is not a guarantee. Creditors use various factors to make the decision, including your income, your payment history, and your credit history, among other things. Your creditor may do a hard inquiry which can drop your credit score a few points and stay on your credit report for up to two years.
This is something you’d potentially want to avoid if you’re doing something like trying to buy a house in the next year or so.
5. Prevent You From Being Hired
Did you know that your potential future employers can run a credit check in most states? They’re not looking at your credit score but instead looking for any red flags on your credit report that could indicate you would be unreliable as an employee. They want to know you’re responsible and trustworthy. How you manage your finances can be an indicator of that.
Accurate negative items on your credit report, like late payments, debt, outstanding balances, or even bankruptcy, can prevent you from being hired. If you do have any unfair negative items on your credit report, you could have more rights than you might think. I recommend speaking with the credit consultants at Lexington Law for more information.
6. Damage Your Relationships
With a low credit score, you might find yourself in need of access to money when you don’t have a cash flow. It could be for a pet emergency, a medical bill, a car accident, or just to cover bills until your next paycheck. Many people lean on family and friends to make ends meet and cover these emergency expenses.
Doing so, especially with regularity, can really strain your relationships. Even with the best intentions, if you can’t pay your friends and family back, they’ll likely stop trusting you and distance themselves from you.
What To Do About It
Improving your credit score is a way to a better life. With higher credit, you’re seen as more financially trustworthy and therefore less of a risk to creditors and lenders. In a world that moves on credit, this is an important step in having financial freedom to choose what happens in your life.
No matter what your financial goals are, whether it’s to move to Hawaii one day, retire early, buy your kids a car, or put them through college, good credit will make the financial aspect a whole lot smoother and less expensive over time.
If you are struggling with low or poor credit, don’t give up hope. You can call and speak with credit consultants at Lexington Law, help establish a game plan, and discuss your path to improved credit. It is always worth the effort to improve your financial situation.
What questions do you have about credit? Let us know in the comments below!