LEVEL ONE / QUICK WINS
Lesson 3: FICO® Fun
By the end of this lesson you'll have learned: 1) The best tools to monitor your credit report, 2) The 5 components of a credit score, and 3) How to boost your score by opening another card. Yes, really!
mastering my credit score - why should i carE?
Even if you don’t think you have an immediate need for a stellar credit score, it can impact your life more than you may realize. Here are a few things your credit score can affect:
Mortgage rates
Apartment rentals
Credit Card offers
Car insurance (in some states)
Car loans, student loans, or personal loans
Security clearance (especially important for military members)
What are the best (and free) ways to check my credit score?
My two favorite apps are CreditKarma and Experian. Both are free and I check them on my phone a few times per month. I highly recommend installing them and allowing push notifications so you can be alerted to any changes to your credit report. Experian has a few paid options that I mention in more detail below, but the basic service is great as it is. (Note that CreditKarma doesn’t provide your true FICO® score, but rather a score based on a model called VantageScore 4.0).
Most banks now provide your actual FICO® score for free
Bank of America, Discover, American Express, Wells Fargo, Chase, USAA, Barclays, and US Bank all provide your actual FICO®. Simply log in and poke around your web interface until you find it. Many will even give you a graph of how it has trended over time. Even if you don't have a credit card, Discover lets you see your FICO® score for free; pretty sweet.
Now that you have your score in hand, let’s talk about why it’s important.
The difference between a top credit score and a poor credit score can literally change your mortgage rate by several hundred dollars per month, depending on the size of the loan of course. That’s why it’s worth investing a few hours of your time now, even if it’s years before you are ready to buy a home.
how credit scores are calculated
To understand how to boost your score let’s first take a look at scores are calculated. There are five components with various weightings.
UTILIZATION
We could spend quite a bit of time on each of these, but I want to focus on utilization. The ratio of credit you are using to the total credit you have available, typically expressed as a percentage, is called utilization. It is the only one of the five components that has no history. Meaning, it could be 80% this month and if you lower it to 10% next month, your updated score is based on 10%. Because of the fact it has no history and also because it accounts for the second-largest percentage of your score, I find this component the easiest one to tweak to increase your score.
real world example
We’ll use my coworker Bill as an example (true story)! I gave a talk about credit scores and Bill was able to boost his score in just two months by lowering his utilization. Bill had $5,000 of available credit with only one open card. In a typical month he charged $2,000 worth of expenses and paid it all off (accrued no interest). His utilization was calculated as: $2,000 / $5,000 = 40%.
If you are like Bill and have a utilization above about 10%, applying for a new card or raising your existing credit limit, can actually help your score. It may seem counterintuitive, but take a look how it may help. Bill applied for a new Chase card and was granted a $15,000 credit line. He then had a total of $20,000 of available credit across two cards. Assuming he maintains his typical expenses of $2,000, his new overall utilization was: $2,000 / $20,000 = 10%.
He decreased his utilization from 40% to 10% by adding another card. That was a pretty significant drop, and he got himself under the key 30% threshold that is often referenced. 40% to 10% will obviously have a bigger impact than lowering your utilization from say 4% to 3%. (Another way to lower your utilization is to make a mid-cycle payment to your account, so when the statement closes the balance is lower.)
It should go without saying, but I’ll mention it just in case. If the additional credit will tempt you spend more, it’s not a smart idea to get more credit! Also note that you can expect your score to drop about 5 points for the initial hit of applying for a new card. But as you can see from the table above, utilization accounts for 30% of your score while recent inquiries account for only 10%. The temporary drop should fade away in 2-3 months and you should see a boost when the additional utilization is reported.
You want to keep your overall utilization low as well as your per card utilization. If one card has only a $500 limit, don’t put $400 on that one. Some issuers will increase your credit limit without a hard pull (defined below), or will let you re-allocate your credit if you have several cards with them. (For example, I have several Chase cards. Before I close one out, I re-allocate my credit line on that card to another Chase card that I plan to leave open, thereby protecting my utilization.)
other credit tips
There are many more important aspects of your credit score to learn about, which we will go over in future lessons. In the meantime, here are 5 other tips I’ve curated over the years:
#1: Keep you oldest cards open and be sure to put at least one purchase on them each year.
Otherwise, they risk getting closed due to “inactivity”. It costs the banks money to report to the bureaus each month and if you aren’t using your card, some issuers will close it down. (My brother sadly had his oldest credit line of 15 years closed by Citibank due to inactivity. By the time he realized it and called to plead his case, it was too late).
I have several old credit lines open that I don’t use for day-to-day purchases, but I use them once per year to keep them active. I call these my “workhorse” cards and their purpose is to keep my average age of accounts high. When I want to open a new card, these cards balance out the young age of my new cards. Take a look at your average age of accounts in CreditKarma and you can see your oldest credit lines in one place.
An easy way to keep them active is to bring them all to the gas station and put a few bucks of gas on each card. Or, simply load 50 cents to your Amazon account and charge it to your credit card.
#2: HARD VS. SOFT PULLS
There are two types of credit inquiries: a hard pull and a soft pull. A hard pull is done by another institution, usually a lender or bank, when you are applying for new credit or a loan. The lender is obtaining a copy of your credit report from one of the three bureaus and it counts as a “ding” against your score. Try to minimize hard inquiries and don’t just open a card to save 10% on a $125 Gap purchase. Personally, if the value to me isn’t greater than $400, I’m not agreeing to a hard pull.
Soft pulls do not count against you or “ding” your score. They do show up on your full credit report but are only visible to you. Soft pulls occur when you get your own credit, a bank who has already extended you credit checks your report for changes, or you search for pre-screened credit card offers. Checking your own credit via CreditKarma, Experian, Mint.com, or annualcreditreport.com does not hurt you.
#3: ANNUALCREDITREPORT.COM
Government regulation allows you to obtain a free copy of your credit report annually from each of the bureaus. The above link is the official government sanctioned page and you won’t be charged for obtaining a report (provided you don’t opt-in to any additional services.) I set a recurring Google Calendar reminder to check one of the bureaus every 4 months
For example:
Jan 1: check Experian
May 1: check Equifax
Sep 1: check TransUnion
This way you are getting a full copy of your credit report every 4 months, for free. CreditKarma and Experian also have excellent free apps. I highly recommend installing them and allowing push notifications so you can be alerted to any changes to your credit file.
#4: Worried about fraud or identity theft?
Consider an “Initial Fraud Alert” or possibly a “Credit Freeze.” If you have reason to believe your Social Security Number has been compromised or just prefer to be cautious, you can set up an Initial Fraud Alert for free with any one of the bureaus. I’ve always done this with TransUnion but it can be started with any of the three bureaus. By law, the bureau you place it with must notify the other two bureaus as well.
An initial fraud alert simply asks a lender to reach out to you on a phone number you provide before extending credit. For example, a note goes onto your credit report for 90 days that states “I believe fraudulent activity may be occurring on my behalf. Please contact me at 415.555.5555 before extending credit in my name.” I’ve done this many times and it’s a nice, free, safeguard. Note that you won’t be auto-approved for any credit cards or loans while this note is on your account. This isn’t a problem, you can just call the lender and provide verification.
A credit freeze is something different and it just recently became free as a result of new legislation. A freeze literally places a “lock” on your report and blocks a prospective lender from accessing your report until it is unfrozen, which can be done only by you with a PIN provided to you when you froze your report. Don’t lose your PIN if you chose to freeze your report! Some bureaus make it much easier to freeze / unfreeze your account. I pay $4.99/month for Experian’s basic service and I can simply “Lock” and “Unlock” my credit report with the long-press of a button in the Experian app. I do it right before applying for a credit card or moving in to a new apartment, for example.
#5: apartment hunting
Many apartments buildings or landlords understandably want to view your credit report and may use it to evaluate you against other tenants who have applied for the same unit. I pre-emptively provide a copy of my FICO® score, CreditKarma printout, and full credit report when I apply. Most of the time the landlord says this is sufficient and doesn’t need to pull my credit, saving me a hard pull, and saving them $30. A few times he or she wanted to pull it directly from the bureau, which is fine. If they insist, ask for a copy for your own records. Being on top of my credit score and having it ready when I apply has helped me land my top choice apartments in tight housing markets such as San Francisco and Seattle.
As you can tell, there’s A LOT to learn about credit scores. I hope you take away a better understanding of how your score is calculated and how to possibly increase your score by decreasing your utilization.
some of my favorite no-annual-fee credit cards
1.5% cash back on everything.
Especially powerful when combined with the Chase Sapphire Reserve; then it’s 2.25% back on everything.
2% cash back on everything. Not everywhere takes Amex so it's good to have a backup card. Personally, I use this card and redeem Membership Rewards points through my Amex Schwab Platinum to get a net 2.5% cash back on all purchases.
Military readers take note: Amex has a generous interpretation of the SCRA and graciously waives annual fees for all their cards, including all flavors in the Platinum lineup!
Reminder that Fireside Finances does not use referral or affiliate links. We always put you, the reader, first, and never want to give the impression we are recommending a card, account, or product for our financial gain. There are referral bonuses for the two above cards, so if you are feeling generous, find someone who holds that card and make them an extra $100!
FIRESIDE FABLE
A friend of mine (let’s call her Alicia) unfortunately missed a payment to her credit card and dinged her perfect record of 100% of payments on-time. Doh! To avoid this, I recommend two things:
Auto Pay: Put your accounts on Auto-Pay! I suggest setting it to pay the statement balance in full, but if this worries you that you’ll overdraw your checking account, simply set it to pay the minimum payment. That way if you happen to forget to pay your bill, the auto-pay will kick in and prevent a missed payment from being reported to the credit bureaus.
Paper Statements: I’m a big environmentalist and fanatic recycler/composter, but my finances take priority. I’ve found that paper statements help me avoid missing any credit card bills, especially with dormant cards that I may not often use. Most banks won’t send a paper statement if you have a zero balance, so that’s good. It’s harder (for me at least) to overlook paper mail than an email in my inbox letting me know my statement is ready.
Let’s get back to Alicia. She needs to minimize the damage her missed payment made on her score. CreditKarma will tell you the number of total payments on your credit report. Let’s say Alicia has 75 total payments, 1 of which was late. Her % of on-time payments is now 74/75 = 98.7%. Not bad, but not 100% either. I explained to Alicia that she could “dilute” the effect of the missed payment by making on-time payments on her other cards each month. It doesn’t matter the size of the payment, $5 or $5,000, it’s still one on-time payment. It’s a long play, but by making more on-time payments you are increasing the denominator of that ratio more rapidly, minimizing the effect of the missed payment. This works well if you have several dormant cards that you normally don’t use.