Everyone nowadays babbles on as to how important a good Credit Score is but very few people when asked know WHY it’s important and to WHOM. More importantly perhaps, most people don’t even know what a Credit Score really is and how it’s generated. That said, when push comes to shove it’s really hard for most regular people to understand why is it important to have a good Credit Score.
What is a Credit Score?
First things first, let’s identify what a Credit Score actually is. The most known credit score is generated by a private company called the Fair Isaac Corporation, or FICO. FICO is a financial analytics company based in the US. What is a FICO Score and why is it important? | myFICO
FICO creates a Credit Score for each individual who has been extended credit and it ranks the risk of providing credit to that individual based on a formula that it created.
This credit score in turn is used by the majority of banks and other entities in the United States to determine the credit worthiness of this individual.
The FICO credit score is generated from several pieces of credit data about an individual and grouped into 5 major categories that are specifically weighted in a specific way.
Credit Score components
These 5 categories are as follows with their respective particulars and weighting that make up your Credit Score:
Payment History (35%): The history of your payments on all accounts, including whether you’ve paid on time, how late payments were, and if any accounts went into default or were sent to collections.
Amounts Owed (30%): The total amount of money you owe creditors. This includes the total debt, number of accounts with balances, and the proportion of credit lines used (credit utilization ratio) among other things.
Length of Credit History (15%): The age of your oldest account, the age of your newest account, and an average age of all your accounts.
New Credit (10%): How many new accounts you have. It also looks at how many new accounts you have applied for recently, which might represent a risk to lenders.
Credit Mix (10%): The different types of credit you have. This includes credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans.
So why is the Credit Score important and to Whom?
Building wealth is a long-term endeavor that requires careful financial planning, strategic investments, and prudent decision-making.
While many factors contribute to wealth accumulation, one aspect that often goes unnoticed is the importance of a good credit score. Your credit score is more than just a three-digit number; it is a valuable asset that can open doors to numerous financial opportunities.
Credit scores can range from 300 to 850 in the FICO system, with scores under 580 considered “poor” and scores over 740 considered “very good” or “excellent.”
The following aspects of your financial life are affected directly by your credit score. These financial aspects, and others, have a huge bearing on whether you will be able to build wealth over time and have financial success due to the cost of capable and the ability to get it.
What is affected by your Credit Score
1. Access to Favorable Interest Rates and Loan Terms:
A good credit score grants you access to favorable interest rates and loan terms. Lenders perceive individuals with high credit scores as less risky borrowers, offering them lower interest rates and more flexible repayment options.
By securing loans at lower interest rates, you can save significant amounts of money over the life of a loan, thereby preserving your wealth and increasing your financial resources.
2. Easier Approval for Credit and Loan Applications:
Having a strong credit score simplifies the credit and loan approval process. Lenders are more likely to approve credit card applications, personal loans, or mortgages for individuals with good credit scores.
This increased accessibility to credit empowers you to seize investment opportunities, expand your business, or make significant purchases that align with your long-term wealth-building goals.
3. Enhanced Insurance Rates
Believe it or not, your credit score can impact your insurance premiums. Insurance companies often use credit-based insurance scores to assess the likelihood of a policyholder making claims.
By maintaining a good credit score, you present yourself as a responsible individual, reducing the perceived risk for insurers. Consequently, you can secure lower insurance premiums, which can translate into substantial savings over time, providing you with additional resources to invest and build wealth.
4. Better Rental and Housing Opportunities:
A good credit score opens doors to better rental and housing opportunities. Landlords and property management companies often evaluate creditworthiness when selecting tenants. With a strong credit score, you demonstrate financial responsibility, increasing your chances of securing desirable rental properties.
Alternatively, if homeownership is part of your wealth-building strategy, a good credit score will position you favorably when applying for a mortgage, providing you with access to better loan terms and a wider range of housing options.
5. Employment and Business Opportunities:
Your credit score can impact your employment prospects. Some employers consider credit scores as part of the hiring process, especially for positions involving financial responsibilities or requiring security clearances.
A good credit score reflects fiscal discipline and reliability, making you an attractive candidate. By securing better employment opportunities and potentially higher income, you can accelerate your wealth-building journey.
6. Building a Solid Financial Foundation:
Establishing and maintaining a good credit score is fundamental to building a solid financial foundation. It promotes financial discipline, responsible spending habits, and accountability. A strong credit score reflects a history of timely payments, low credit utilization, and a well-managed credit mix.
By cultivating these habits, you not only improve your creditworthiness but also lay the groundwork for wise financial decision-making, debt management, and long-term wealth accumulation.
7. Access to Investment Opportunities:
Having a good credit score can provide access to investment opportunities that can accelerate wealth building. It enables you to secure favorable terms for investment loans, obtain business financing, or participate in real estate ventures.
With a strong credit score, you can leverage borrowed funds to invest in income-generating assets, diversify your portfolio, and potentially achieve higher returns on your investments.
8. Financial Flexibility and Emergency Preparedness:
The ability to have ‘options’ in times of need is crucial for most families to get beyond a hard time or a financial bump in the road.
Being able to cover an emergency car repair as an example with a credit card is made possible by having a credit score high enough to qualify for the card to begin with.
In addition, many homeowners keep equity in the their home available as a ‘financial reserve’ through what is called a HELOC or Home Equity Loan.
This essentially is an open loan instrument that normally has a set interest rate that is charged against funds borrowed or used, similar to a line of credit of sorts. In order to get a HELOC in the first place, and one with favorable interest rates, is a product of a good credit score.
Conclusion
As you can see, our credit score pretty much dictates the health of our financial life, unless we have the ability to pay for everything in cash. I’m certainly not against the ‘cash only’ movement and in fact,
I strive to pay for all consumable items and non-income generating assets (cars, furniture, etc.) with cash but to create wealth through assets like rental income properties and businesses, it’s going to be important to be able to secure debt financing.
Furthermore, as identified in the preceding post just about every aspect of life from education to housing to transportation is impacted by our ability to have a good credit score.
It’s important to note that not all financial activities affect your credit score. For example, checking your own credit, known as a “soft pull,” does not affect your score, while applying for new credit, known as a “hard pull,” can temporarily lower it.
Also, certain bills like rent, utilities, and medical bills are often not reported to credit bureaus, although unpaid bills can eventually be sent to a collections agency, which would negatively impact your credit score. Improving your credit score generally involves paying all bills on time, using a low percentage of your available credit, having a long history of credit use, and avoiding excessive applications for new credit.
