I was visiting a house of worship last Sunday – no, I didn’t have to wear a name tag – and while listening to Pastor Ryan (who coincidentally is also a lawyer) talk about the ways in which one can gain wisdom, the life lesson he discussed has applications far beyond the realm of morality or matters more spiritual.
In particular, I was struck by a three-part prescription at the center of his sermon that was seemingly tailor-made for the thousands of folks who, over the past two decades, have daily asked me how to improve their credit:
- Learn from the mistakes of others.
- Learn from your own mistakes.
- Let The Expert guide you.
Now, in spiritual terms, these three suggestions aren’t necessarily earth-shattering. It goes without saying that we can learn from the miscues of others and, in so doing, hopefully avoid making the same mistakes. The same goes for our own private missteps, and the painful lessons to which they give rise. Obviously, the third is preferable to watching others fall on their swords or personally putting ourselves through an experiential meat grinder.
Learning from the credit mistakes others have made shouldn’t be too difficult. We all know someone who has been turned down for a loan or didn’t get approved for a lease because they had a bad credit score. Examples of friends and family overspending abound. You don’t need to accumulate a mountain of debt to know that it isn’t a great idea.
Learning from our own mistakes, while often unpleasant, is even easier in a sense, because it doesn’t require compromising another person’s privacy (or dignity). It is not unusual for a person to make a late payment—whether through temporary negligence or lack of funds. Accounts get closed, credit limits get lowered and divorces happen, without this or that shared account getting severed. Credit mistakes are a part of life.
If you want some expert knowledge regarding a good credit score, there are a few rules that can be extracted from a basic knowledge of how credit scores are concocted. Once learned, the basics of how credit scores work will become the equivalent of muscle memory in your daily life and help you build good credit.
Your credit score is compromised of five components:
- Payment history matters. The first commandment when it comes to maintaining good credit is, “Thou shall treat a payment due date as a deadline, not a guideline.” Timely payment, late payments, non-payments are all reported, and account for up to a hefty 35% of your score. Always pay on time, if not early. If you are concerned that you might be late, or miss a payment, ask the lender to automatically debit your account on a certain date every month.
- Credit utilization represents some 30% of your score. Try to pay off your revolving accounts (i.e. credit cards or lines of credit) in full every month. This helps you avoid interest charges, but also shows lenders you know how to use credit responsibly. If cash flow constraints prevent you from doing that, keep this example in mind: If you have $5,000 in available credit, you should try to keep the unpaid balance during any given month below $1,000—better yet, $500. The less debt you carry, the better risk (or lack thereof) you represent to a lender. How much you charge to your credit cards impacts this factor the most, and if you’re carrying a balance, interest charges can quickly take you from the good credit zone into dangerous territory.
- The age of your credit accounts for 15% of your score. Whenever possible pay down debt, but do not close accounts. Closing an account can impact both your credit utilization ratio (See #2) as well as the age of your credit.
- Your mix of accounts matters. Ten percent of your score is based on what kinds of credit accounts you have. The more varied the better here. Lenders like to see a healthy mix of “installment” accounts like car loans, a mortgage, or a student loan and those “revolving” accounts like credit cards.
- Hard inquiries are 10% of your score. The more credit you shop for, the more that potential lenders might think you are a little too interested in building your spending power—which is a positive spin for potential over-crediting and financial difficulties.
You can get a look at how your credit scores are impacted by these five major factors by getting a free credit report summary every month from Credit.com.
A central story in the Abrahamic tradition—Judaism, Christianity and Islam—highlights an apt illustration for the first of the above three suggestions. Adam and Eve’s eviction from paradise is, among other things, an instructional (and cautionary) tale. The essential lesson—put into secular terms—is that authority matters. The original couple only had one job: to co-exist with creation. They could till the land and eat the fruit from any tree, and they could be happy and content, so long as they did not disobey one house rule. Don’t eat the fruit. Well, you know how that went, and we’ve been talking about how we alternately like or dislike them particular apples ever since.
While the theological ramifications of one of the world’s central creation stories are profound, a simple take—obedience to a fixed set of rules—is something we can all understand. Applied to your credit, it can mean the difference between a new house or a new landlord; the 2016 model of your favorite car or off-market parts bought with a high-interest credit card. It’s your decision.