Financially Fit in 5

5-Minute articles to make your finances
simple, easy, and care-free.

The Bottom Line on Credit Scores

I was watching a business channel this week, and I was a bit surprised to learn that 76% of young adults are financially illiterate.  It turn out that the overall rate for adult financial literacy is at 66%.  It has been told to me that most children learn finances from their parents, and these numbers show that might not be the best approach.

Over the next several months I will be posting on basic financial literacy topics.  Today’s blog is on understanding your credit score.

FICO stands for Fair Isaac Corporation.  They provide the software for calculating your credit score.   But that’s not what matters.  It’s understanding what your FICO score is and what that score means.

There are five grades of score.

  1. Excellent                   Score of 800 or higher
  2. Very Good                Score of 740 – 799
  3. Good                        Score of 970 – 739
  4. Fair                           Score of 580 – 669
  5. Poor                         Score of 579 and lower

Your FICO grade (score) indicates the level of risk associated with offering you a loan.  If you have an excellent FICO score, there is little risk that you will not pay your bills.  In truth, to be more specific, it is the risk of you being 90 days or more past due on any debt within the next 2 years.   I am using the word “loan” but you should think of that as any bill that comes into your household.  Not paying your doctor’s bill can affect your credit score.

What determines your FICO score?  The largest percentage (35%) of your credit score is your payment history….another words paying your bills on time.   And while it’s most important to pay on time, it also includes how much you pay.  If you are paying only the minimum on your credit cards each month or paying just a portion of a bill, that will hurt your FICO score.

The second most important thing (30% of your score) is the amount of debt you owe.   You should be aware of what your available credit is your loans and credit cards.  It’s an easy number to find – just log into your account online and look for words like “available to spend,” “available credit,”or  “total credit limit.”  If you are close to using all your available credit, it will hurt your score.   Having a lot of loans and credit cards can also hurt your score.

The third item that affects your FICO score (15%) is the length of your credit history.  Once you open a credit card or start paying your car insurance, your utilities, and the like, you start to create a credit profile.  The longer you have credit in your name (and use it wisely),  the more advantageous for your credit history profile.

If you have a lower FICO score, you can end up paying much more than an individual with a higher FICO score.  Not only can it affect your ability to get the best loans rates and credit card interest rates, but your rent and your insurance premiums.  Best way to keep that score high is to pay your bills in full and on time each month.