This change could impact how lenders measure risk.
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You may have heard the news lately about credit scores across the country getting an unexpected boost.
That may sound like cause for widespread celebration, but as it is with most financial issues, it’s not quite that simple. If you have a less than optimal credit rating, and this results in a boost, then that could be a good thing for you. But what if you already have excellent credit? How will you be impacted?
First, why do we have credit scores?
Your financial health is just as complex as your physical health and having a financial advisor — much like having a doctor — is only part of the equation. How you manage your money is just as important as how much wealth you have accumulated. We’ve all heard stories about lottery winners or professional athletes blowing through their massive wealth in a matter of years. Don’t be that person.
To truly understand your credit worthiness, the banking industry needs a way to easily measure your behavior, so they developed the credit score. However imperfect the scoring may be, it is the method that has been used for several decades to determine the likelihood of a borrower paying back their loan. Creditors have trusted these credit scores along with the accompanying credit report to identify which potential borrowers are good investments and which will likely result in negative returns.
How does my credit score impact me?
When planning your financial future, there are internal factors (like your savings) and external factors (like your investment performance and interest rates) to consider, and your credit score impacts both categories.
Your credit score, which can range from 300 (uh oh) to 850 (hooray), is an indication of how desirable you are to a potential lender. When your credit score is low, it impacts your ability to borrow money and the rate you pay to borrow. At worst, you risk not being approved for a loan, a house, a car. At best, you pay higher interest rates on everything from credit cards to home loans. This situation can leave you with less money to save for retirement month after month. When your credit score is high, lenders compete for your business and sometimes will offer much lower rates or excellent incentives, simply because you are a safe investment.
Your credit score is determined by your past financial behavior: Do you always make your payments on time or have you fallen behind occasionally? Have you taken the time to build your credit in the first place? Are you carrying too much debt relative to your income? Have you experienced a bankruptcy?
Sometimes, you’ve checked all the right boxes, and your credit rating is still low because of issues related to identity theft or errors in your report. Rest assured that you are not alone. In fact, the Consumer Financial Protection Bureau found that incorrect information on a credit report is the top issue reported by consumers.
How will the recent changes impact my credit score?
Earlier this year, the three major credit reporting companies started excluding all civil judgement data and tax liens from credit reports, after a study from the Consumer Financial Protection Bureau recommended changes to credit reporting.
That caused about 11 percent of the population to see a jump in their credit scores. In some cases, the boost was as much as 30 points. That may not seem like a lot, but when you’re working hard to improve your credit score, every little bit counts.
But the news isn’t all good for consumers. Some analysts have argued that recent changes in credit reporting, and the subsequent boost in credit scores, could create a situation in which lenders who rely on the credit score struggle to differentiate between a risky borrower and a reliable one. This could result in lenders requiring a higher score to borrow. If you didn’t see a boost from the changes, this could, in theory, be a negative for you. Some lenders may even elect to raise rates across the board to account for the additional risk — which isn’t good for anyone. We won’t really know the answer until we’ve had some time to see how this all shakes out.
What can I do to make sure my credit rating is protected?
The best defense is a good offense. A good credit rating still matters immensely, so if you’ve got it, protect it.
First, keep a current copy of your credit report on hand. The three major credit agencies allow you to request one credit report per year for free, so if you plan properly, you can check your report three times a year without coming out of pocket. Some banks even provide credit scores to their customers for free each month. It doesn’t necessarily matter how you go about getting your credit report, as long as you are doing it.
Next, Look for inaccuracies and areas of concern on your report. Identity theft struck 16.7 million people in 2017 alone. If you’ve been a victim of identity theft, you want to know sooner rather than later, so you can begin the process of correcting the errors. And, despite what you may have heard, checking your own credit report will not lower your credit score. Many organizations offer credit monitoring which takes some of the burden of constant monitoring off you, and can even alert you when there are changes to your report. This can be a good option for very busy individuals. Just make sure that you aren’t caught off guard when you go to apply for new credit.
Have a plan for your debt
As you may have heard, not all debt is bad. In fact, how would creditors know if you are a responsible borrower, if you’ve never borrowed? On the other hand, excessive debt is never considered a good thing when evaluating a person’s credit worthiness. In most cases, it helps your credit score when you pay down your debt.
In recent years, we’ve become a culture built on credit. People are using cash less and less. We want the credit card miles or points (rightfully so), and the ability to pay later rather than right now is always a temptation. But, that can create some problems:
- We can overestimate the cash we’ll have available by the time the credit card bill arrives, leaving us struggling to pay off our balance in full. Carrying a balance from month to month results in finance charges and excessive balances (relative to your limit) can negatively impact your credit score.
- We can buy whatever we want, whenever we want, because credit means there’s always money in the bank. This often results in people overextending themselves.
Splurging every so often doesn’t necessarily mean you are careless, but if it becomes a problem, you must create a plan to recover. Shelling out high interest payments month over month is like throwing your money in the trash — or more accurately, into the hands of someone other than yourself.
Be careful when opening new accounts
Exercise caution when applying for and opening new credit card accounts. While it’s true you need credit to build credit, it won’t substantially raise your credit rating to open a slew of new accounts. It does, however, increase the odds of burdening yourself with excessive debt.
The good news amid all of this: If you’ve read this far, you’re already taking a step in the right direction. Whether it’s rectifying errors in your credit history or turning over a new leaf, you’ve decided to take action when it comes to your credit rating. Remember, stay on top of your credit report and make smart purchasing decisions, and you are on the right track. Your financial health is looking better already.
Securities offered through Triad Advisors, LLC . Member FINRA/SIPC.
Advisory services offered through Meld Financial, Inc.
Triad Advisors and Meld Financial are not affiliated.
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