Credit Scores: How I went from 500 to 720
I’ve been thinking about my credit score recently. I purchased my car last year and will have it paid off in the next two months by paying additional payments. My interest rate was 5.6%, so the opportunity cost to pay the scheduled payments over 48 months was very high which is why I am paying it off early. However, with that loan ending, I would only have two credit lines open – student loans and my one credit card. Having just one installment and one revolving credit account open could negatively impact my chances at getting credit financing because I wouldn’t have enough history on my account.
To remedy this problem, I’ve been researching additional credit cards. I finally chose the one I wanted and it’s a solid complement to the one I already have. After applying and being approved for the card I chose, it noted I had a 727 credit score. 727!? Woohoo! That means since I purchased my car last February I went from a 500 credit score up to 727 on just three accounts.
The Road to a 700 Credit Score
When I purchased my car, I had not quite secured my loan through my local credit union. They had told me as long I didn’t lie, I’d be solid, but the underwriters had not finished their analysis. So with this verbal understanding, I went shopping. I found the car I wanted and told them I would be back tomorrow to actually purchase if they can hold it for me on our agreed upon price and the purchase would be contingent on financing. They agreed, but offered to run my profile to their lenders and see if we can work something out today. I figured, more quotes are better, so heck yeah! This is one of those moments where I tell you I made a mistake, so pay attention. My score for financing through my credit union was 540. By the end of the day after my dealer shopped me around to 25 DIFFERENT LENDERS WHO ALL DID A HARD INQUIRY, my score was now an even worse 500. After the third or fourth hit, my score was already dropping quick so I received mostly rejections; the ones who did approve me wanted 12% financing! Even me credit union, who I ultimately got the loan from, rejected me through the lender because my score was too low at that point (luckily they took my initial application, rather than the lender profile). I was furious. When I asked their financing director what the heck he was thinking allowing 25 different people to hit my credit his response was “it’s not my credit, I’m just trying to get you a loan.” Lesson learned. Never ever use dealer financing, always go in with your own approved credit. If you are forced to go with lender financing, give them a maximum number of lenders to shop around with. One other note, if you’re able to, always pay cars with cash, not credit. Generally, the return on alternative investments will be lower when compared to the interest rate on auto financing – thus, pay cash if you can.
So that’s how I got a 500 credit score. The road to 700 is a little bit more pleasant. I ran my credit report at annualcreditreport.com. You get a free report from all three bureaus once a year per federal law (for what it’s worth, I get one report every four months). I noticed I had a $25 medical co-pay that somehow didn’t get collected. I settled that debt and kept everything else current. Slowly and steadily, I paid my student loans, my car payment, and paid my credit card every month. I have never carried a balance on my credit card, I pay for my groceries and gas and then pay it off when the statement comes. It’s a myth that you need to carry a balance to actually improve your score. Here I am, 16 months later, with my credit score 220 points higher. It’s a boring story, but that’s what finance is sometimes. Just paying your bills on time and building a history of paying your bills on time. The more credit accounts you have the quicker the score goes up. One caveat though, stay under 30% credit utilization that is total amount you spend on credit each month divided by your total available credit.
Understanding the Credit Score
The credit score is just an answer to a formula. Think back to high school algebra when you had equations that was like 1x+2y+3z=a. That’s all a credit score is. So let’s take a look at what makes up the equation.
- Payment history – This makes up 35% of your total score. That means any negative history (debt in collection) is incredibly bad for your score. Keeping a clean record is the single most effective tool to increasing your score.
- Amounts owed – This may be where the “carry a balance” myth comes in considering this is worth 30% of your FICO score; however, it’s equated even if your pay your bill every month, so you might as well pay your bill. Basically, it’s just the credit utilization. If you have two cards with $1,000 a piece, and you spend $800 a month between them, your credit utilization is 40%, which is higher than most companies would like to see.
- Length of history – FICO doesn’t explain in great depth how this category is factored, but at 15% of your total score, it’s not a large portion. The longer you have accounts in good standing, the better this is.
- Credit Mix – At 10% of your score, it’s not too essential to think about how you’re utilizing credit. However, it takes a look at the breakdown of your total credit: retail lines, credit cards, installment loans, and student debt.
- New Credit – Again at 10% of your score, this looks at the length in between looking at opening new lines of credit. This is essentially why my score dropped 40 points in 20 minutes. If you don’t make it a habit to open financing lines, you’ll be fine.
Readers, how does your credit score look? Do you have any funny learning moments when it comes to understanding how credit works? Share them below! Be sure to like Cash Flow Celt on Facebook and share the article if you found it useful. Keep taking steps to conquering your financial empire!