Let’s face it. There are several daunting and even scary financial words (student loans, recession, depression, etc). But here’s one you might not know: FICO. Before you panic, let me explain.
For those who are not familiar, FICO is a credit reporting system started by the Fair Isaacs Corporation. It is a numerical measurement of your credit worthiness that ranges from 300 to 850. Your FICO score is used by most lenders to determine whether or not you can obtain credit. In fact, because of lack of financial education and the current state of student loan debt, most people may feel like FICO has done nothing but hinder them.
Your score can stop you from getting loans, renting or buying a home, purchasing a car, opening a bank account or even getting a job. Getting a handle on your FICO score is easy if you educate yourself on how FICO is calculated and then discipline yourself.
The five categories used to calculate your score are:
- How much debt you have
- Your payment history
- Your debt usage ratio (how much you owe in relation to your credit limit)
- How far back your credit history goes
- Your mix of various types of credit
Understanding these five categories can really help you keep your credit in order. And just in case you’re part of the 44 million Americans who have fell behind on their credit, there is still hope. The following are five things you must avoid to keep FICO from becoming a curse:
1) Making Late Payments
Obviously, we should know why this is a big no. But here’s why: credit is given based on your ability to pay back your obligations on time. Late payments simply show creditors that you are having a hard time meeting your obligations and stay on your credit report for up to seven years. It’s imperative that you avoid them at all costs. However, if you’ve made some late payments in the past, it’s not the end of the world. As you continue to pay on time, the late payments will have less of a negative impact. The key is discipline and showing creditors you are responsible.
2) Carrying Big Balances
Most people don’t realize this but creditors usually extend credit to those who they don’t think need it with the hopes that they’ll use it eventually. Carrying a big balance show creditors that you are having issues and are relying too heavily on the credit to get you by. This has a negative effect on your credit score as well as your ability to obtain new credit. As a rule of thumb, you should keep your usage down to about 30%. (Example: If your credit card limit is $1,000, you should not carry a balance greater than $300.)
3) Closing a Credit Line
Closing a credit line can hurt you in two ways; first as I stated just a few moments ago, you want to keep your usage down to 30%. Closing a credit line increases your usage because you no longer have that credit limit available to you. It can also affect you because you may be getting rid of a rich part of your credit history. If you have a card that’s been open for a while and you’ve been making payments on time, it is best to keep that card open. Most people close credit cards because they may have received a new card with a better rate and don’t want to have too much credit outstanding or might be trying to avoid an inactivity fee if they’re not using the card. Keep in mind that you lose more by closing your old cards. Best thing to do is to call your current credit card provider to negotiate a lower rate or fees.
4) Having Too Many Credit Inquires
Anytime a creditor checks your credit, it affects your FICO score by two or more points. The deduction in points may only last for up to 2 years, but it is still important to use caution. Keep in mind that you can check your credit as much as you want yourself without any effect to your credit score. With that in mind, I suggest that you know your score whenever going anywhere to obtain credit and inform your potential creditor of your score prior to applying to anything.
5) Defaulting
Defaulting on any type of loan or credit card is the single worst thing you can do to your credit. Defaulting will surely get you declined for any new loans and should be avoided at all costs! If you ever foresee that you can’t meet some or all of your obligations, it is imperative that you reach out to your creditors as soon as possible. Most will be willing to work with you.
All in all, FICO can be your friend if you treat it right. Treat it wrong and it will become your worst nightmare. Start getting a grip on your debt by using our Student Loan Consolidation and Debt Payoff Calculator to estimate your monthly payments and get a head start. You’ll be surprised at how getting a head can save your heartache and pain. If you are in a situation where you need to fix your credit, pick up my best-selling book What the FICO: 12 Steps to Repairing Your Credit, It’s a simple guide that will give you step-by-step instruction on how to go from bad to good credit in no time and minimal cost. If you follow these simple steps you are going to begin the journey of getting your credit and financial life back in order.