This is a guest post by Michael Squier.
In the next 5 minutes, I will save you tens of thousands of dollars.
This should be a no brainier, but I’m sure many of you will be disappointed when you find that I’m not talking about a stock pick, or a magic money mutual fund. It’s something that actually exists; it’s your FICO score. If you don’t know what I’m referring to, think it has something to do with sports, or are just plain scared to discuss this topic; read on. Your FICO score is your credit rating and it can make and save you money. There are a few simple tips you need know to take control of your credit score, show it whose boss, and ultimately save you tens of thousands of dollars.
The Stats
The average American’s FICO score is 686. Scores range from 350-850 (citations; more on this later). The average credit card debt is $8,400, with an average interest rate of 13.15%. It takes between 22-24 years to pay this debt off.
Lifelong Grade
If you are reading this article it is my guess that you are striving to be anything but average. I want you to think of your FICO score as a lifelong grade, and even though “C’s get degrees” they will not make you rich. Since you are able to read, I can also surmise that you have gone to school and are able to remember grading scales. I want you to consider your FICO score as a grading scale that will stay with you for the rest of your life. This is your lifelong grading scale.
FICO scores range from 350-850.
780 above = A+
720 - 779 = A-
680 - 719 = B
620 - 679= C
550 - 619 = D
549 below = F
Leading the Curve
The good news is, there is no homework needed to improve your score. There are many different ways to improve your score, but we are going to focus on the major 3. I promise this will not require a finance degree.
1. Make your payments on time. Baring a major catastrophe, you should not spend more than you can afford. If you cannot pay off your credit cards each month, then you are spending too much money. That’s the bottom line. If right now you can’t afford to pay off the full amount, make sure you make your minimum payments each month on time. Lenders report to the three credit bureaus (Transunion, Experian, Equifax) each month. What they are reporting is your ability to pay back your loan, and to pay it on time. If you pay on time, your scores go up. If you pay late, your scores go down. Simple.
2. If you do carry a balance, try to keep your balance less than 40% of your high credit limit. For example, if your credit card limit is $1000, you want to keep your monthly balance under $400. The higher the monthly balance carried on your loans, the more it appears as though you are unable to pay off your debts. Would you lend money to a friend who owed a large amount of money to two other friends? Many lenders won’t either. The higher the carried balance, the more risky you become. The more risky you become, the more expensive your cost of money in the form of higher interest rates. Simple.
3. Don’t close old credit cards; pay them down. This may be different from what you have heard in the past. There are two reasons why you should keep your cards open. The first is that the credit bureaus want to see a long history of on time payments. If you close down that card, then the payment history is erased. Second, if you close your cards then you will affect your overall credit ratio negatively. We discussed this in the last paragraph. If you carry two credit cards with $1000 balance, your total available credit is $2000. Let’s assume one card has a $300 monthly balance and the other has a $500 monthly balance. Your carried balance would look like this: $300 + $500 = $800 monthly balance. $800/$2000 high balance = 40%. If you close down the $300 credit card your equation changes: $500/$1000 = 50%. Your risk has just gone up, which negatively affects your credit score. Pay those cards down. Keep your history for future lenders to view. This will improve your score. Simple.
Let’s assume you have followed through on the last three tips, and your credit scores have gone through the roof. You are earning an ‘A+’ on the FICO grade scale. One of the first things you will notice is a change in your mail. Instead of receiving collection company mail, you will start to receive love letters from an unlikely source, lenders. Credit cards will offer you 0% to transfer your balances or to open a card. Car dealers will give you 0% for a new car purchase. If you own a home, banks will offer you interest rates below prime on home equity loans. Money will be thrown at you.
Interest rates are directly related to risk. Having a high grade let’s potential lenders know that you are a low risk. Your low risk is rewarded with low rates. You become valuable. Your ability to leverage money has increased, and your ability to finish rich has taken a turn for the better.
If you are still not convinced that the past 5 minutes have been worth your time, let me give you one last dramatic example. Let’s look at what will most likely be the largest purchase you will ever make, your house. Let’s compare ‘Jack A.’ vs. ‘Jack F.’, and control every other variable that goes into qualifying for a loan, other than FICO score.
Jack F:
| Loan amount | FICO score | Interest rate | Payment | Total interest |
| $300K | 549 | 8.25% | $2,253.80 | $511,367.93 |
Jack A:
| Loan amount | FICO score | Interest rate | Payment | Total interest |
| $300K | 785 | 5.75% | $1750.72 | $330,258.68 |
Over the life of the loan, Jack A. will save $181,109.25. Tens of thousands of dollars! Simple.
- Michael Squier, the author, is a professional in the world of Real Estate Finance, but he’s much happier drinking wine with his fiancée Rebecca. You can reach him by email with any questions or comments at mpsquier@aol.com.
- Some sites for further information:
http://www.bankrate.com
http://www.annualcreditreport.com
http://www.experian.com
http://www.transunion.com
http://www.equifax.com
