Demystifying Your Credit Score & Does It Matter

What exactly is a credit score, and does it really matter? 

Let's demystify the concept and explore its significance.

Around 90% of lenders use credit scores to assess potential borrowers, which means it directly impacts the loans you can get, the interest rates you'll pay, and the terms you'll be offered.

It also affects your ability to rent a home, influences insurance rates, determines utility deposits, and even impacts your job prospects. In short, your credit score holds significant sway over your financial opportunities.

In this episode, we're going to crack open the vault and dive deep into the world of credit scores. I'll break down exactly how they work, what factors influence them, and, most importantly, how you can improve and maintain a healthy credit score. 

Take charge of your financial well-being today. Hit that play button and empower yourself with the knowledge to make smarter financial decisions.

IN TODAY’S EPISODE, I DISCUSS: 

• What credit scores are and why they matter for borrowing
• Five levels of credit score
• How FICO Scores are calculated

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Get your FICO score for free: https://www.myfico.com/credit-education/whats-in-your-credit-score
Get your free credit report: https://www.freecreditreport.com
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Transcript

Mel Abraham: 1:56

Does your credit score matter? How the heck did even calculate these numbers, yet they hold your ability to borrow in the balance. So here's the deal. In this episode, the Affluent Entrepreneur Show, we're going to demystify the whole manage them? Do they really matter? Where do they matter, and all that. So I'll see you in the episode. This is the Affluent Entrepreneur Show for entrepreneurs that want to operate at a high level and achieve financial liberation. I'm your host, Mel Abraham, and I'll be sharing with you what it takes to create success beyond wealth. So you can have a richer, more fulfilling lifestyle. In this show, you'll learn how business and money intersect. So you can scale your business, scale your money, and scale your life, while creating a deeper impact and living with complete freedom. Because that's what it really means to be an affluent entrepreneur. Welcome to this episode, the episode on commercial this one we're going to talk about credit scores, we had a conversation around housing should you buy should you rent and you know what, you can't talk about that without understanding also how credit scores can come into play, when it comes to buying a home or even renting or those kinds of things? What is this thing this, this kind of mystical number that is calculated out and never never land that they call credit scores that start to drive the level of interest rate loans, you get? Jobs, all those things? So first things Let's just touch on, why should this even matter? Okay. I'm going to walk about why it matters. What are the different levels? How it impacts your your ability to borrow? What are the key drivers? And what do you need to do to make sure that you're managing your credit score effectively? Alright, so let's jump down to the iPad. And the first thing is that when we come to this idea of how does why does it matter? Well, first things first 90% of lenders use it, they use one form or another of your credit score as a metric as to whether you should be approved as a as a potential borrower, what level of loans are going to get you what kind of interest rate what kind of terms, okay, it allows people to get loans faster, because all of the mashing of the numbers and the things are done by the credit reporting agencies not saying that they're, that they're all accurate. Results, show you one way that you can actually, I think put you in a better position from a credit score perspective. But the fact is that it's counterintuitive that it works that way. But it does because of the way they look at it. So the other thing that happens is that it supposed to allow them to make credit decisions that are fair, that aren't biased with, whether it's gender, whether it's race, whether it's any of these other other things. It allows people to be able to navigate beyond mistakes, look, we, we all make credit mistakes, I make Chrome mistakes, I ran out credit cards, I missed some payments, I have done that work where you're human, but allows us to reduce the impact of the mistakes over time because instead of shining the light on that one flaw that one blemish, they look at the whole totality of your credit, they look at the whole totality of of some of the things that you do, it makes more credit available because lenders are more willing to loan or lend because we they have a base in which to evaluate everyone across based on the same criteria all all around now. The idea here is this. Look, I'm not one of those people that say all debt is the devil. Okay? But I'm also one of those people that I don't want you in debt. If there's any way to avoid it, and at some point I want you to completely out of debt. There are two characteristics I think that there's there's productive debt and destructive debt. So productive debt is that debt that you take on to increase your net worth or cashflow that will increase your net worth and your ability to live without your efforts down the road. Destructive debt does neither of those destructive debt is to finance lifestyle is to finance consumables, it's to buy big screen TVs, luxury items that you don't necessarily need but you want but the reason you're putting it on debt is because you can't afford it today. That's a mistake. I want you to at all costs, avoid destructive debt. And be smart about using productive debt because all debt will cost it's called interest no matter whether destructive or or, or productive All debt will stress you like it or not stress you psychologically, because it's his burden. It's an obligation that's over your shoulders, it will stress your life and it will stress your financial situation. So no matter the category of the debt, it has those two characteristics, it will cost and it will stress you. So I don't want to just go into debt, go into debt go into debt, I actually overtime once you completely out of debt, and buy things at the speed of cash over time. But I know and I understand, especially if you're a business owner, that there's debt involved, we need to be smart, we need to exercise it differently. Now, this episode is solely focused on the credit score part of it, we can talk about the debt as a separate issue, but understand that that's my perspective on it. The other thing that happens is that you get a better interest rate, the higher your credit score, the better the terms are, you can negotiate on, on either loans, credit cards and things like that, and I have done it repeatedly. Here's the other thing, you might say, Well, no, I'm not buying a house, but you know what your landlords use it. A higher credit score makes someone a better tenant possibility. So they see a higher credit score, they see responsibility, they say, well, we shouldn't have a problem collecting rent. So they do that. Believe it or not, it affects your insurance rates, higher credit scores get better insurance rates, even then, when you go into a property and you got to do utilities, a lot of times, if you have higher credit scores, you can actually get out of putting any kind of utility deposits down, we did no utility deposits on this hole. Okay. And many employers these days will check credit reports because they want to see responsibility, they want to see if there's a financial burden, they want to see these things that come into play. So these are the reasons why it actually still matters, whether you're borrowing or not borrowing, there's other aspects of the credit score system that will infect or affect your life as as you move forward. But there's five levels of credit scores that you need to look at. And you can be at one of these five levels and you will move throughout my credit score goes up and down based on what I charge on a credit card or what I pay off. But you want to be you want to understand where these categories are and where they break. So here's the five categories that you will see, the first category is a credit score below 580 or below 580, they're going to say that you are a poor, kind of a risky borrower, let's just say you're a risky borrower, you're well below the average score of of the population of scores they have. So you're below the US consumer scores, you are a poor borrower, that means that you're a risky borrower, it doesn't mean that you're poor financially, it just means that you've had some bad payments, you've got bad credit history, you've had maybe a bankruptcy or or what have you, well, they're going to take that in consideration if they're going to lend you money because they say, Well wait a second, this person has a, for lack of better term, a checkered past. Okay? And they penalize you for unfortunately, but it's the way that that they play the game. Now, the next level up goes from poor to fair. So that is from 580 to 669. Okay, you're still considered below the average of US consumers, but you are, have got a better chance of getting loans, you can get loan still with a fair credit score. Now, those loans may have a higher interest rate, not as advantaged terms, those kinds of things may come into play because of your credit score. Number three, this third level up is good. This is 670 to 739 is the score that's close to or slightly above its surrounding the, the the national average, okay? So it's the national interest, this, this is where lenders actually become more comfortable, they kind of go, okay, they're, they're about average, they're there in the population with the majority of consumers, so they feel more comfortable lending to you. And then we move up to these last two, the next stage up is a very good score. So 742-790-9747 99 is is is a very good score. And that is puts you above the average of the population of US consumers. They see you at this stage as a dependable borrower. That means that they're more likely to give you more advantage turns to more likely to let you rent to you and do those things. In in making that happen now, above 800 above 800 puts you in the exceptional category. Now they see you as an excess showboat borrower, you are well above the average of the US consumers. So this is where you're going to get the most advantaged best rates, terms ability to negotiate, because they're looking at you and saying, This person is a, a solid, solid person, lowest risk category of little doesn't mean that things can't go wrong. I've watched people with exceptional scores and up in the in the poor score category, because they had some things that went wrong, went south on them. But the likelihood they're playing a probability against the likelihood that that happens, is far smaller. And you might sit back and say, Well, what does this really even matter? Here's how this matters, I'm going to show you the difference between each of the categories based on your credit score, if we were to borrow a rate, because what happens is they start to set the interest rate they're going to offer you based on credit scores. So this is something that I pulled from a from a source that actually does this. And so if you look at this at at 762, to 850, they would offer you a 5.9 point percent interest rate, which means that your home payment on a 30 year fixed$400,000 loan is going to be$2,383. Well, what if your credit score was down in the 660s, at 660, that interest rates goes up to 6.55%, your payment goes up to two almost 2550. So your payment goes up, you know, $200 a month, and other $25 a year. The the, if your credit score is down at the 620 range. Now your interest rate is up at seven and a half percent. Now your payment is at 2805 means that you're you're almost $500 a month more in payment for the same loan, the same thing, he might go well, okay, but I can afford the 500. Well watch what happens. If you look at how much interest you pay, if you look at the interest costs that you pay, you're going to see how much more you're given the bank because of credit scores, because over the life of the loan, at the 768 50, you're going to pay for it and $57,000 in interest. But if you're down to 620, you're gonna pay over almost $610,000 in interest. So you're gonna pay$150,000 $152,000 more interest to the bank, over the life of a 30 year mortgage, if you had a low score versus a high score. So it does have a material impact on your life and on your financial life and your ability to build wealth, your ability to get yourself to financial freedom. So managing this credit score becomes important. And if you're going to manage the credit score, what goes into the calculation now, he'll give you a ton of information about it. But here's, here's a pie chart that actually shows you what really matters in this. And the first and the most important is actually your your payment history. 35% of the score is calculated based on your payment history. So you want to make sure that all of the payment history in your credit reports are accurate. If you had no late payments, but they're showing late payments, you need to get it corrected. Okay. So one of the things you want to do is go to free credit report report.com Free credit report.com and get your credit report your credit scores once a year at a minimum and look at it, make sure that you're verifying that things properly to make that happen. So 35% is payment history. And 30% is the amounts owed, meaning that they look at how much how much you owe on the credit card compared to the amount available on the credit card. So they look at if you have a credit limit of$10,000 on a credit card, and you you have a balance of 7000 they say that's a 70% borrowing rate. If you have 3000 against 10,000. It's a 30% borrowing rate. So one of the things you want to make sure you do is try to make sure that you are utilizing this as utilization 30% or less of the total credit on your credit cards. So if it goes above 30% It starts to really eat into your credit, your credit score, okay? The third big category that they use to keep Calculate your credit score is the length of credit history. So this is looking at the longest credit cards or the longest outstanding loans with good payment history. So this is why we tell people you don't close out credit cards, because if I have a credit card that you've had for 20 years, even if you don't use it, even if you don't use it, that 20 year history helps you to the tune of 15% of the credit score. So you can reduce the credit limit, which I wouldn't advise, you can leave it alone, put it in a drawer, and and leave it at that. But you don't close the old accounts, because then it shrinks that history, and it will have an A, at least a short term impact on your credit score. Especially if you're thinking about buying a house or you need to get a loan for a car, you don't want to do any kind of activity on the credit report that can that can end up you know jacking your credit score up a bit, then there's two other little things that come into play the last 20% Because these three elements account for 80%. Of of your credit score, the other two are smaller 10% things is, is new credit. If you're applying for new credit on an ongoing basis, every time you apply, it's going to it's going to hit your credit, they're going to look at an inquiry and it can affect your credit report. So you want to limit your credit requests, especially as you're going into the potential of borrowing something in the future. And then the last piece is is the credit mix. Okay? In other words, do you have nothing but credit cards do you have store credit cards, gas cards, major cards cards like like Visa, MasterCard, American Express is a mortgage loans is it car loans, having a variety of credit is better but not required. Okay, it's only 10% of the score, but you to you, the more variety you have, the more they will see you as someone that is able to manage debt payments and risk effectively. So but by and large, the three biggest things to to make sure that you deal with is that payments on time, you're not over utilizing the credit available to you. In other words, you're not living at the limits of it, you're going to keep that below 30% in that you have your credit history, you leave stuff all because the that's 80% of the credit to do that. So if we're going to do that, here's eight things I want you to look at to manage your credit and your credit score moving forward. Okay. So the first is this is that I want you to make sure that you're making on time payments, it is 35% of your score, do not make a late payment, whatever you can do, make sure that you're making on time payments, it's just too much that can that can come into play, you can have too much of an impact on the credit score. Second, keep your credit usage low remember, less than 30% of credit usage. And then also think about how you pay your credit cards, pay them strategically, okay, in other words, how you use them and pay them pay them strategically to stay under the 30% especially if you are carrying a balance if you're carrying a balance and you're trying to get out of debt. We have a Debt Breakthrough Calculator that we'll make sure we hook up in the description and Michelle it's that is actually a tool that you can put all your stuff in, put yourself on a strategic timeframe to get your debt your your debt paid off in a way that either minimizes the interest or minimizes the time or takes away the emotion because it gives us the process to do it. It comes with a short me training you on how to use it totally free. We'll make sure we hook it up here in the show notes for you pay him strategically. Number four. Actually, this is counterintuitive. Raise your limits. ask for a raise limit. Here's why. Watch what happens. Remember, this goes back to this credit usage low, you want to keep the credit uses low. If let's say I have a $10,000 credit limit, let's say I have a$10,000 credit limit, and I'm carrying a balance of 5000 on the car. I carry a balance of 5000 It's 50%. That's over the 30% usage that they like, but if I went to him I say I would like to get an increase in my credit limit. This is counterintuitive, but it works. I would like to get an increase in my credit limit to $15,000. Well, now, they increase it to $15,000. I still have the $5,000 balance but $5,000 against 15 is 1/3 instead of 50 percent, it brings the credit usage percentage down, which pushes my credit score up. totally counterintuitive, because you have more borrowing capacity, which could make you more risky, but they look at it as less risky, because what you've done is you brought the usage percentage down, which is 30% of the credit score. So sometimes asking for increased limits can help your credit score for a period of time. Now, don't push that. Just because you have a bigger credit limit doesn't mean you keep pushing it up, you want to keep this below 30%. Then, then from there, I want you to review your credit report regularly, like I said, Credit Karma, free credit report calm, I got no association with them, you can get it once a year, I want you to look at everything on there, make sure that the payment history is correct that all the credit is on there that you need to have on there. And to make sure that that is there. If there are delinquencies, if you're late on anything, deal with them, don't put your head in the sand. Deal with the delinquencies, get them cleared up, get them dealt with, get them taken care of the sooner you do that, as hard as it may be, the better off you'll be with your credit score down the road. Number seven, is if you don't have a lot of credit, you can actually get credit for utilities and your payments, your rents and all that stuff. So make sure that you can get that into the credit report and consideration for that. And there's ways to do that, with the credit reporting bureaus to give you credit for that for that, and then build a credit mix and a file. In other words, you're not going to just have credit cards, you're not gonna have just car loans, you're going to try to create a mix, but you want to build a credit file in the credit bureau. Yield, they have the document that you're managing in the sense of overseeing and making sure it's correct. But now when they when someone pulls your credit, they see a mix of credit, they see your credit history is long, they see the credit utilization is below 30%, they see that the payment history is on time, that's going to push you into that exceptional very good to exceptional credit category over time, which is going to bring down your rates, which is going to give you better terms is going to give you more negotiating room and more ability to be more fancy financially sound long term in the future. Remember, the difference between an exceptional rate and a poor rate was over $150,000 in additional interest on a mortgage loan because the interest rate that they would have gotten. So this is the importance of having credit. Now I don't like I said, I'm not going to go into productive destructive debt any deeper than we already did. But what I do want is that over time, I want you to completely 100% on a debt. But over the journey, you're probably going to have some debt elements in there, mostly productive debt, steer clear of destructive debt, and keep yourself on the journey manage this piece of your financial life. It'll give you and pay you in spades down the road with respect to job with respect to rents with respect to buying and purchasing and rent and mortgages and other loans down the road. I hope that this helped. I hope this shed a light on demystifying this idea of credit score and what it means to you, and how it can affect you. If you have questions, if you have something that comes up where you want to, to have me answer your question or guide you through something, please go to ask Mel now.com That's what I'm here for. It's what I'm here to do. Leave me your question. I'll put it on an upcoming episode. I might even reach out to you and bring you on the episode. Coach you live and help you. Alright. The purpose is this I truly believe that everyone has a birthright and that birthright is to be financially free. We just got to go and claim it and we got to guide you to do it. I'm not selling you investments. I'm not selling insurance. I'm not selling any of that stuff. I want to sell you on your dreams and the possibility of them. Okay, till we get a chance to see each other another episode on the road while speaking or anywhere else. Always, always strive to live the life that outlives you. Cheers. See you. Thank you for listening to the Affluent Entrepreneur show with me your host Mel Abraham. If you want to achieve financial liberation to create an affluent lifestyle join me in the affluent entrepreneur Facebook group now by going to melabraham.com/group and I'll see you there.