Credit Score and Credit Report; you will be hearing about it quite frequently in the US. Credit Score is a reflection of your creditworthiness that is universally available to banks, credit unions, insurance companies, utility companies, landlords etc. Your credit score is generally used by financial institutions to cater a product for you. Basically, the higher your credit score the better the interest rate you will receive. There are more than 20 versions of credit scores. For general purposes usually the FICO score is used. Credit score is a numeric value calculated through proprietary formulas and It ranges from 300-850 (or 250 – 900 depending on the version used by lender).
Let’s see the benefits of high credit score in these two hypothetical examples. First example is a car loan and second is a mortgage.
So, the first customer has a credit score of 680 and second of 770. Obviously the second customer was able to get better interest rate on a five-year car loan and over the life of the loan will save more than $2,000 on loan payments only because the customer has higher credit score. Imagine saving more than 10% of your loan amount in the form of the interest.
Let’s now look at a mortgage example. Same customers with same credit scores needing to finance $300,000 mortgage loan. The second customer will save more than $40,000 over the period of the loan!
Your credit score depends on few factors that we will cover in details later on here and is based on your credit report. Your credit report indicates your personal information, credit products and public records. All your credit lines and lending products, any default payments, late payments, delinquencies, any bankruptcies, outstanding balances and others to name few.
It’s really important to keep your credit report error free as it impacts your credit score. As a US resident you are eligible for one free credit report from all three major credit agencies Experian, Equifax and Transunion. Check it regularly to make sure its error free. You can check it for free at: www.annualcreditreport.com
The information on your credit report is usually used for additional level of identification. You will find later on that some of the financial institutions will be asking you questions which are based on your personal history, such as which of the following addresses have you lived at, what’s the name of the city where your home on street x was located and others.
Let’s get back to the credit score now. It’s important to understand what the credit score consists of so that you can understand how to build and improve it. Remember credit score is derived based on your credit report, which contains the following:
- Your payment history
- Your credit utilization ratios
- Hard inquiries
- Your credit age
- Your credit mix
Don’t worry we will cover these items individually and explain what they mean. I have also included a picture from my credit score which shows how these factors play together and in percentages.
The graph below was provided by Citibank to me, because I have a credit card and they provide their customers with an ability to check your score for free every month.
So, let’s start.
You can see that one third of your credit score is influenced by your payment history. This is why timely payments on your electric bills, credit card, loans, rents etc. is critical. You need to keep this on track.
Your credit utilization ratio or the amount you owe, is your outstanding debt divided by your total loan products. It’s important to keep this ratio low. We will cover some specific suggestions later on.
When you apply for a loan product, credit card, phone installment or apartment rental the lender triggers hard inquiry (new credit on the picture above). Hard inquiry is used to verify your credit worthiness. Typically, the hard inquiry will have a minimal impact on your credit score.
Now, what you need to know is that there is also a soft inquiry, its usually used to verify your background. Typically, its work background check, or you checking your credit score and credit report. Don’t worry, soft inquiries have no impact on your credit score.
Your credit age, is simply your credit history. The older the better, this is why it’s important not to close your old credit cards.
Credit mix (type of credit) is basically all your credit products. The more diverse your portfolio is the better. Banks like when you have multiple loan products, credit cards, personal loans, auto loans and mortgage loans. Obviously, you might not have all these products at the same time, but you can have few.
Now let’s talk where you can check your credit score for free. You can use such services as Credit Karma or Credit Sesame. I signed up for both, but frankly have not checked either in a while. There reason? Majority of banks offer the same service and you can check it when you log in to your account. To name few: Chase, Bank of America, Citi, American Express, Discover. But you might be starting, and have an account with a bank that does not offer this service.
Fear not. Before the major banks started offering this service, I was using this website:
This website was built by Discover. I think they offered free service to attract more customers. Nevertheless, it serves our purpose well.
Now that we are experts in credit score and where to check it, lets discuss how to build it from scratch or improve it.
First step if you are just getting started, get a secured credit card. Secured credit cards are relatively easy to get since you need to deposit certain amount of money and will have a credit line equal to that amount. E.g. if you deposit $500 you will get $500 credit line.
I would suggest to get two secured credit cards and spend no more than 2-6% of your credit line. Make semimonthly payments to avoid interest. I would pay off with my every paycheck, but even if you don’t the interest will be minimal. Also, remember to make timely payments. This is most important. After 6 to 12 months or so bank will analyze your spending and payment pattern they will convert your credit card to unsecured and will return your deposit.
I would also suggest that you get the secured credit card with no annual fee. Remember the credit score structure? Age of the credit is one of the factors, so you need to get a fee free credit card because you will keep it for your lifetime basically.
Where to get secured credit card? Few of the examples below, but before you apply always check terms and conditions to make sure there are no annual fees.
1. Capital One® Secured Mastercard®- no annual fee but also no other incentives.
2. Discover it® Secured – no annual fee and provides cashback!
3. Citi® Secured Mastercard® – no annual fees but also no cashback or other incentives.
These are just few of the cards. There are much more, just google and remember to check fees.
Second, 6 months after getting credit cards consider getting a secured credit loan. Having secured credit card and a loan will definitely help with building credit score, because you are getting a good mix of loan products.
- PNC Bank
- Wells Fargo
- TD Bank
- US Bank
These are just few that provide the secured personal loans. If you google you can find more. I personally took one from PNC bank. What you also need to ask is when the Bank will start reporting your loan to credit agencies. In case with PNC Bank it was no sooner than 6 months.
Remember with secured personal loan you will be paying interest. I remember for my $2,000 I had to pay a total of $140 but it was well worth it.
Alternatively, you can google the term “credit builder loans”. There are some credit unions and small local banks that offer this product, which can be similar to personal secured loan. Just be careful and read the terms and conditions before signing up.
Car loan will also boost your score, but be prepared to pay high interest in case it’s your first car. Take it if you have to, if not you will have an opportunity later on in your life.
There is also a novel service that takes into consideration your phone and utilities bills. I have not used this service personally, it did not exist when I came to this country, but its worth checking especially since its free! Experian currently offers this service and you would need to register for it.
Now what you need to know to this service is that is free and will use your checking account data to see your utilities payments. If you use other forms of payments this model wont boost your score. Also, please note that it only boosts Experian score, so if your lender is not using Experian score, you might not benefit from it. But who knows, does not hurt to boost your score at least once and see how your score will change.
Another service that provides a product to help you build your score is https://www.self.inc. Again, just like the one above, I have no experience of using it and can not say whether it works or not. The idea behind this product is that they offer you a small loan which is held by a bank (you are not getting money) in a CD (you will get small interest) and they ask you to make small payments over period of time. The payments are subject to fees and interest, so it can get costly. After you are done with your payments, the CD will mature and you will provided the “loan” you requested, but now its your money.
Want to reiterate, I have not used this service. If you are willing to try or are using this service, please let me know your experience (send me a note through contact form).
Getting a cosigner on unsecured debt (loan or credit card) is another way for you to build a credit. However, unlike the strategies described above where you can rely on yourself, in this particular instance the person with good credit score and history needs to trust you. If its your family member not a big deal obviously, but for everybody else it will be a sensitive topic, since not everyone will want to trust you. So be careful with your choice.
One type of institution that may trust you is called Community Development Financial Institutions. Basically, these are credit unions and banks that aim at building communities and providing banking products to customers who might not be eligible to these products otherwise. NerdWallet is a great source for CDFI and not only. If you are interested to learn about Community Development Financial Institutions and would like to see the list of these institutions by states please visit NerdWallet:
We have covered some of the initial steps you can take to start building your credit score. Remember you need to be always on time with your payments! With little time and effort you will build a solid credit score, just remember to check the terms and conditions of the products you are going to chose and don’t be afraid to ask questions! Good luck!