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Credit: What Really Does and (Doesn’t) Matter

Posted by Bill Bianchi on Jun 14, 2017 9:26:43 AM

Your credit history can impact whether you’re approved to open credit card accounts in your name, or if you can secure student loans, auto financing or home loans at competitive rates. Your credit history may even determine whether you’re approved to rent an apartment or secure a job with certain employers.

Here’s a look at which factors in your financial life (credit history) play a role in how your credit score is calculated, and which may never play a role in calculating your credit score. But first a couple of definitions…

Credit

Money (or goods or services) provided to an individual with the expectation that the amount borrowed (or value of the goods or services) and all interest will be repaid over time.

Credit Score

A number which is based on a mathematical algorithm that reflects your credit worthiness at a specific point in time.

  • Think of your score like a test score in school. Higher scores are better. They give you a wider choice of lenders and improve the term of the loan you may qualify for. Lower scores limit your choices and make borrowing more costly. Credit scores help lenders determine whether or not you will repay a loan.
  • Lenders may use a number of factors to reach their decisions, including your credit history, credit score, current debt, current income, payment history and employment history.

Credit Report

A history of how the borrower manages credit. An accumulation of information regarding payment history, amount borrowed, credit limits, delinquencies and defaults.

How Your Credit Scores Are Calculated

FICO and VantageScore are two of the most popular credit scores — but since many credit scores are industry-specific, you may have more than 50 possible credit scores. Those scores may vary slightly, but most are based on a few specific pieces of criteria, including:

  • Payment history. Hopefully, you will never miss a payment. If you do, pay what you owe as soon as you realize the due date has passed. The longer your payment becomes past due and the more frequently you miss the payment due date, the more negatively it may impact your credit score. Missed payments could remain on your credit report for several years.
  • Balances on your credit accounts. The amounts of your account balances are the second most important factor in your credit score calculation. High credit balances (compared to your available credit line maximum) may cause lenders to believe you are a higher-risk borrower who is financially reliant on credit.
  • The length of your credit history. The longer you’ve managed credit in your name, the more beneficial it may be to your credit score. The credit or loan accounts you’ve owned the longest may contribute the most to a positive credit score.
  • New credit. If you apply for and/or open too many new accounts in a short period of time, it may negatively impact your credit score. (This is true even if you apply for a new credit card account at a store to receive a store discount, and never intend to use the card).
  • Your credit mix. Credit cards are considered revolving credit: there is a beginning – when you open an account and are given a line of credit. You choose how much of it you use, when to use it and when to repay the entire balance or a portion of it. Once you make a payment, you’ll have more available credit (up to your maximum credit amount). A revolving line of credit works like the fuel tank in a car; you start with a full tank of gas (which allows you to drive many miles), use some, use some more and what is available goes down (and the number of miles you can continue to drive goes down). Stop at the station and add some gas and the number of miles you are able to drive goes back up. There is no end. A car, student, or home loan is an installment account; there is a beginning, a predetermined number of payments due, and an end when the balance is paid in full. You don’t have the ability to borrow more just because you’ve made a payment. Your credit score may be positively impacted when you own a mixture of both types of credit.

What Is (Usually) Not Included in Your Credit Score

Your credit score helps lenders, creditors, landlords and some employers see how much risk they might take on by doing business with you, based on how you’ve managed credit. When your credit history and credit scores are positive, you may be offered more competitive rates and terms on loans and credit products.

That said, a creditor or lender must report account information to the credit bureaus in order for it to appear on your credit history (which then factors into your credit score). For that reason, you may have financial accounts that will never show on credit report, because no money, goods or services were provided in advance of payment, including:

  • Your debit card activity. A debit card draws cash from your bank account when you make a purchase. It is not a line of credit, and isn’t reported to the credit bureaus or included in your credit score.
  • Monthly utility, rent or cellphone bills. Many utility providers or landlords will not report monthly account activity to a credit bureau — unless you don’t pay, and the account is turned over to a collections agency. (In turn, the collections agency may report the unpaid account to the credit bureaus, which could negatively impact your credit score).
  • Your income. The income you earn is not included in your credit history, or a part of your credit score.
  • Your spouse’s credit activity (unless it’s on a shared/joint account). Your credit history (and credit score) is based on your social security number. Even if you get married, you maintain your own credit history and credit score.

Credit can be complicated, but when you separate the facts from the myths, you’re empowered to take the necessary steps to build a positive credit score. Use these basic tips to start taking control of your credit — and your financial life.

Author bios: Pamela Coleman is Executive Director of Furniture and Mattresses at Conn’s HomePlus, a 125-year-old consumer goods retailer headquartered in The Woodlands, Texas, with expertise in international and domestic buying, category management, product development and sourcing. Bill Bianchi is Manager of Financial Literacy at RISLA. 

 

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Topics: Financial Education for Students