Credit scores: How They Work, How to Maintain a Good One, and How to Fix a Bad One

Welcome, everyone, to this week’s Finlit by EWA podcast, joined here by Jameson Smith. And today we’re going to talk about credit score. What is it? Why is it important when you have it mastered? Why it’s not that important to track it, other than some general things you should do on a month to month, year to year basis.

 

And then we’re also going to talk about for if you have kids or if you need help repairing your credit score, what are the quickest ways to do that? So, Jameson, let’s start with giving us a first, just a basic overview. How does credit work? Hopefully some clean analogies we can use to clearly describe it.

 

Yeah, well, just so your credit score, what is your credit score? It’s a three digit number between 300 and 850. It basically shows your credit worthiness. So the worthiness of a lender, what’s the risk of them lending you money? Basically is like simplest term. So if it’s higher, obviously it’s good. If it’s low, it’s not good, and you’re at a high risk, basically. There’s a good analogy I like. It’s like if you were to climb up a ladder, the higher you get on the ladder, the higher your score is. You just have access to more lending, lower interest rates, basically better deals on what any bank would lend money to you. And there’s different ways we can climb up that ladder, which we’ll dive into.

 

Yeah, absolutely. And I want to use a couple of analogies here. So there’s a couple of points. So there’s people we’ve seen that obsess over their credit score in the track too much. And it’s not going to boost your financial well being once you hit a certain level. And then there’s also people that have a good financial well being that don’t use any credit that actually ends up hurting them. So I’m speaking specifically like the Dave Ramsay crowd.

 

I don’t know if they still use cash and envelopes to pay bills or whatnot, but you could have a perfect no debt, a good financial plan, and then you have this fortress of investment accounts, and then you want to go take a loan out although you’re probably in the top 10% of the, you may not be able to get a loan or even get good terms on the loan. So there’s a balancing act here. We don’t want to obsess over this, but we do obviously want to have a good credit score. And there’s simple tactics to get first. So there’s three credit reports. There’s Equifax, Experian, and TransUnion. You can also use some websites to get a free look at your score. These are estimates. So, for example, credit karma, credit sesame. These are free websites.

 

Experience free.

 

Yeah. And so the credit karma and credit sesame, those are just estimates. If you want to get your actual credit score, you have to pull it from the three agencies I just mentioned. So, with that being said, let’s dive into how is your credit score calculated? There’s five factors. Correct?

 

One, two, three. Yeah, five.

 

So, James, let’s start with the first.

 

One, which makes up 35% of your score. It’s a payment history. So basically, just making all of the. Paying all your bills on time. If you have any credit card balance, you’re at least making the minimum payment or paying it off. But if you go one of these sites, it’ll show, like, for each account you have. So if you have a credit card, it’s been open for two years. It’ll literally list every single month in the last two years and show you if you’ve made the payment or not.

 

Absolutely. And literally, this one is the least amount of your control, because it just takes time to solve this issue if you don’t have credit, and each month isn’t going to factor into getting a good payment history. So if you’re looking to put your credit score on steroids in a quick amount of time, this is one that’s out of your control. But in general speaking, we are big believers in points and maybe utilizing welcome bonuses with different credit cards. We have. Bryce Conway was on the podcast a couple of weeks ago and talked extensively about that. I personally do that, but because of this exact reason, the payment history, if you have a credit card you’ve had open for ten or 15 years, that one you’re always going to want to keep open.

 

And then new card, that’s okay to open and close once you have a rock solid score that established. So the second one is amounts owed. This is also referred to as a utilization factor. So, for example, if you had Jameson $10,000 worth of credit available, and you were consistently spending $5,000 a month your utilization factor would be 50%. Well ideally want to keep that below 10%. So if you’re going to spend 5000 a month, ideally you want to open up 50,000 a month worth of credit so that you’re at that 10% level and this makes up 30% of your score. This is one of the quickest ways to get your credit score up is probably the opposite of what most people think. It’s basically open up as many accounts as you possibly can and don’t use them. I’m sorry. Don’t use them.

 

Use as little as possible and then make sure you pay it off in time on a month to month basis. But make sure that general thumb utilization under 10% is going to be really good. And the discipline you show if you have 50,000 available that you could spend you’re only spending 5000 or less and you are paying it off on time every month is going to do wonders very quickly to your credit score.

 

Yeah. And one thing to note, this is not like tracked historically. It’s just literally at the time of the report what you’re utilizing generated. So you could have it 100% for your whole life and then pay everything off and then you’re good.

 

And then suddenly you have a 10% utilization, you’re good. Yeah, like literally the quickest one and I think the other. Bryce actually used this analogy but it made so much sense to me. If you’re taking two college classes you get one a plus and 1D. Your GPA is not going to be good because it’s the average of the two. But if you take ten college classes, get nine A’s and 1D, well the average of that you’re still going to have a rock solid GPA and it’s not going to affect your job search after.

 

That’s the same when it comes to a lot of credit score, having a lot of accounts, low utilization, et cetera, that’s going to make, if you do make a misstep it’s going to make it negligible versus if you have one account and make a misstep you’re going to see a huge impact immediately in your score. But if you have a long withstanding on a lot of cards low utilization, you make one misstep. Just like the gpa example, it’s going to have very little impact. Or if it does it’s going to be something that you can recover from very quickly. Okay, next up is length of credit history. So James, how much of a factor is length of credit history and how.

 

Does that determine this makes up 15% of your score. And this is just the amount of time you’ve been using credit. So what’s interesting is, like you mentioned the oldest account, you never want to close, which is true, but it’s the average of your accounts is what makes this up. So you could have one account that’s ten years old, and then all the other accounts are brand new and they’re going to come meet for an average. So definitely keep the oldest accounts you have open. But I guess realistically, the more older accounts you have will actually help this too.

 

Awesome. Then the next 10% is just new credit. So get new credit inquiries, soft inquiries, and then there’s hard inquiries when the credit is actually pooled. If you’re getting a mortgage, this impacts the score the greatest temporarily. Your FICO is only affected by inquiries over the last twelve months. And there’s a special rule. If you’re applying for a mortgage and you’re chopping it around different vendors, different institutions, if you do this all within a certain time frame, it’s not going to count as multiple inquiries. So make sure that if you’re working with a mortgage broker that’s independent or a banker, and you’re doing multiple, make sure to do this all within a short window so it doesn’t ding your score and you can get the best rate. Okay, so next up would be, and last but not least, is just the.

 

Types of loans or credit you have. It makes up 10% of the credit score, but, so this would be like mortgage, student loan, credit cards. What type of loan do you have?

 

So, with those five being said, the payment history, just discipline amounts owed, the utilization factors that we can control right away, length of credit history, obviously is out of your control. New credit, the hard inquiries, obviously in your control, and the types of credit use is in your control. So just a quick rundown of what’s in your control, what’s versus not. So let’s talk about what’s a healthy credit score. So 850 is perfect. I always use the analogy of like, if you can get to, let’s say, between me and the wall is perfect, and I can spend 1 hour and I can get 90% of the way there, and then every hour I spend after gets me halfway closer. So then 90 to 95. The first hour got me to 90%, the next hour got me to 95, and then halfway, halfway.

 

Well, first of all, it doesn’t matter how many hours I spend, I’m never reaching the wall, right? If I just get halfway closer so there’s a point of diminishing returns with credit score. So once you reach a certain score, it’s just bragging rights, but you’re not going to get any better deal than anyone else. Jamie, what’s the sweet spot there?

 

Basically, if you’re above 740, you get the same treatment as 850. So 680 is considered good. Realistically, if you’re over 700, you’re going to get good treatment. And then anything above 700 to 740, really? And above 740, it’s really like not.

 

I’ve heard 760 thrown out there, too. So we’re going to say 740 to 760. If you’re there, forget about it. If you go above that, I would say, you know what? You’re probably not being aggressive enough with new credit card bonuses for free travel. So anything above that, if you have an 800, I have a 750. We’re getting the same mortgage rate, we’re getting the same car loan rate, we’re getting approved for the same kind of stuff.

 

Yeah. And then if you’re over 700 real way, you’re not having any issues with anything for the most part.

 

Absolutely. So why credit is important is if you have a high net worth, there’s going to be inopportune times. If you’re in a high tax year, if the stock market is down, you want to, let’s say, buy a vacation house. We don’t want to sell a stock at a loss. We don’t want to sell something that’s going to trigger a tax when you’re already in a high income bracket. So the way around this is you can take a secure line of credit. You can take an unsecured line of credit against your house. So credit, even if you’re high net worth and you’re financially independent, it’s still important because it’s going to give you short term options, take it out and pay it off with cash flow so you can stay efficient in your long term financial plan.

 

And if you’re not high net worth yet, it’s going to be crucial because there’s going to be several steps going from high school to college. Most likely you’re taking out school loans. Those school loans are going to be the start of your credit journey. And then after that, make sure we’re paying on time, depending if they’re forbearance or not forbearance. But then after that, getting a credit card under your belt, using it responsibly, that’s going to set the tone and discipline, really, for the rest of your life. As you go to purchase a car as you go to purchase a house, maybe you take out a loan to start a business. All of these huge life decisions are based upon you having that credit score. 747 60 and above. Okay, so, Jameson, let’s talk about if someone had a bad credit.

 

Let’s say you’re a busy doctor. You missed one payment. Didn’t mean to. You’re just working 80 hours, weeks in residency, and you missed a payment on your school loans or a credit card. How do we repair that in record time? What are some steps and ideas we can get that back on track with?

 

So the first thing you could try, sometimes it works, sometimes it doesn’t. You go to the lender. So if you had a credit card, and it’s with Chase bank, for example, call chase, make up some, tell the truth, but spin some story about why you missed the payment.

 

I was busy at work. It was 80 hours. I was on call all week.

 

And then put it in writing. Write a letter to them, and then basically ask forgiveness. Sometimes it works, sometimes it doesn’t. That’s first thing. Sometimes they’ll just fix it for you.

 

And that’s a low time commitment. Just write it, send it. Yeah. Done. Okay.

 

Yeah. First you’d want to try to do that. If that can’t happen, like you said, it’s kind of out of your control. You just have to let time play out. We could try to, depending on what your credit score is, if it’s low, you don’t want to go apply for new credit cards. But if you’re able to get more cards to increase the limit, that’s an option. But we basically want to just clean up as much as you possibly can. So first thing would be ask forgiveness. Second thing, pay off any of the debt that you can get the utilization down. And then don’t close accounts generally, because then that’s going to, like we said, the utilization, the history and everything that could throw that off. And then from there, basically make sure you’re making all the payments on time going forward.

 

And then, yeah, those are kind of the low hanging fruit ones. We’ll get into the credit piggybacking, which is another one. But anything I missed?

 

Yeah, I think the credit piggybacking, those are all amazing. And if you have someone that you trust is disciplined in maintaining a good credit, and then they trust you. Let’s just say using my example, I have a five year old daughter. Let’s just fast forward. She’s graduated college. She’s missed a payment. We’re trying to get her credit score, boost it back up. I can add her as an authorized user to one or all of my credit card accounts. And let’s just say I’ve had those accounts at that point for 20 years. She’s from that point moving forward going to start to get the credit for all those on time payments, utilization factors. So within six months, her credit score will almost be like unstoppable. Now when I do that, a common misconception is she’ll have to have her credit card.

 

If she have her own account, she won’t. I can add her as an authorized user. They send me a card in the mail, I can keep that. She doesn’t see it. She doesn’t see even have access to the card or account, but she’s going to start getting all of that. And if she does bad stuff in other credit cards she has, it doesn’t affect me because this is just my account. So credit piggybacking is an extremely efficient, quick way to help a loved one repair their credit score with zero risk. Again, just would recommend you don’t hand the actual supplementary card to the person you’re helping. Just put them on and watch their score increase pretty quickly. So I think a good analogy with credit score is if you educate yourself. I think there’s three categories of people.

 

There’s people that educate themselves through parents or through school, and they get the school loans from there. They make the right steps moving forward. I use analogy that’s like a boulder that’s already moving. You kind of have to keep your finger on it to keep it moving. And then there’s a person that’s not educated that makes a big mistake. Well, to fix your credit score, there’s a lot of work you’re going to have to do. You’re going to have to be on calls. You’re going to have to ask for those forgiveness letters. You’re going to have to ask someone to piggyback. You’re going to have to slowly build it up over time. And so I use that analogy. It’s going to take a long time to push that boulder, but once that inertia is started, then you’re rolling forever.

 

And then the third type of person would just be someone that overly obsesses with a credit card score of like, let’s try to get 850 instead of focusing on other metrics like net worth, cash flow, income tax efficiency, et cetera. So credit score is not something that we look at as a measure of financial health. It’s just a check mark as part of a financial plan. We want to make sure that Boulder then inertia is carrying us forward. But once it is, it’s not something we want to focus on. We just want to use it for our advantage and make sure that we’re never at a disadvantage when opportunities come up to borrow money. So just a general guideline to maintain good credit. Never carry a credit card balance past its due date. Keep the utilization rate below 10%.

 

Don’t ever worry about small swings. There’s going to be rather 30 or 40 point swings I see on my credit card. I know that’s a fake score. I open and close accounts all the time because of free welcome bonuses and credit cards. I’m not worried about that. But I know if I have a big purchase, if I was going to do a a new house in the next twelve months, I’m not going to be that aggressive twelve months in advance because those hard inquiries can affect me up to twelve months. But if I know I’m chilling, I’ve got the car I want to drive for the next couple of years, I’m in the house I want to live in. Why does it matter if my 780 score goes drops to 730 even below that perfect?

 

It’s irrelevant to me because I know I’m not going to ask anyone for money. But twelve months in advance, that’s when I want to taper back and just keep using the accounts I have and maybe be a little bit less aggressive, et cetera. And then once at 750, I never worry about trying to improve my credit score because at that point it’s irrelevant. There’s so many other good things I can focus my time into for actual financial health. Like I just mentioned. Anything else to add on that?

 

Yeah, I’d say a couple of things. Number one, we should have mentioned this in what goes into credit your credit score. But a couple of misconceptions I’ve heard people say, like, oh, I went to medical school or I’m credentialed. Why was my credit score low? There’s a lot of things that have zero, have nothing to do with your credit score other than those things we mentioned. So it is kind of, not that it necessarily always makes logical sense, like you could be a high income earning doctor thinking you should have a high credit score, but there could be missed payments or something that doesn’t make sense. And then second thing I think that’s pretty important is if you are trying to repair your credit score and you’ve done those things that we talked about. So you’re making payments on time.

 

Now you’ve asked for the forgiveness, you’ve done the credit piggybacking and you still have debt that you’re trying to get knocked out. A couple of things just to be aware of. So number one, any expensive debt, look to refinance. Obviously this is interest rate depending, but any interest rate you can get dropped down is going to save you on paying that back. So that could be for mortgage, student loans, car, et cetera. Balance transfers are a good way. Again, once you have the credit score up, you could transfer to a card where you don’t pay any interest for twelve months and then pay it off. And yeah, mainly from there on out, automate your bills, expenses and make sure you’re not missing any payments going forward and you should be good to go.

 

Yeah, absolutely. So I want to talk real quick about that. So a couple of things. So if you have a bunch of credit cards at a minimum to protect yourself, like set up the automatic payment so you never have a late payment, even if it’s not the full thing, just set up a minimum, like the minimum payment you have to make and then still go in, have a reminder set to go pay off the full thing each month. But if you find yourself over your head, you mentioned the balance transfer. So if I’ve got $20,000 of a credit card debt and I’m like the interest on this thing is 20%, the interest alone is 4000 a year. If you find yourself in that position, you can do that balance transfer.

 

That balance transfer is not going to help you whatsoever from a credit score perspective because your utilization is still really high. But we would still recommend that because you can get that 0% for an introductory period of twelve months. Now if you don’t pay that back, you have to check the terms of that balance transfer because it can sometimes go back all twelve months. If you don’t have it paid off within the twelve months, you have to do a balance transfer again. But that can be a good strategy as long as you understand how the balance transfers work. You balance transfer it now you have 0% interest. So now you’re paying money into it and it’s all going towards principal.

 

And then before the twelve months is up, you’d have to do another balance transfer or else a lot of times a lot of that interest goes back as if it was there from day one. So some specific discover it is a card if you have a low credit score, generally speaking, they’re one of the most forgivable cards you can get if you’re starting out with a low credit score, they’ll accept you, and that’s also a good one for a balance transfer as well. But there’s many resources out there to figure out what is the best credit card if you’re starting out, what are the best credit cards? There’s some premium credit cards if you have a good credit score and you’re already established, but it can be a great tool that you can be used to support your life by design.

 

But if you don’t manage this right, it can be a great distraction that’s now depicting how you live your life, and it’s going to cause a lot of stress unless we manage this properly. So Jameson, thanks for joining. Hopefully this is helpful and look forward to catching everyone next week. Thanks for tuning in to our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button, make sure to rate the podcast and please share with any friends or family members that would also find this beneficial. Thank you very much.