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Our credit score is essentially the credit bureau's idea of our ability to repay our debt obligations. The score is highly affected by several factors.
Credit history
Our credit history is the biggest determinant. If we have a poor track record of paying bills or paying them on time, a new creditor is less likely to want to take that chance with us.
Debt to credit ratio
Our debt to credit ratio is also a big factor. If we are close to our maximum limits with most or all of our accounts, a new creditor will not want to offer additional credit. When we max out our credit cards, we show creditors that we are poor at managing our money. We buy more than we can afford. A new credit line will only make it easier for us to get into worse debt.
Also, when we are close to our limits on our cards, our required payments may get high. A new credit line will only be an additional bill, and a creditor may not want to take a chance that we cannot afford to pay the new bill.
Length of history
The length of time that our credit has been established gives a creditor a track record. If we don't have a long history, a creditor may not be able to get a good idea of our ability and willingness to pay.
Number of open accounts
Opening lots of credit lines can have a negative impact on our report and our credit score. This is especially true if the accounts are recently opened. Creditors will wonder why we are so desperately seeking so much capital. Too much credit can lead to trouble. They don't want to compete for our payment. They want to feel comfortable in knowing that they will receive their payments as expected.
Scores are important
Each bureau uses a different scoring system, but the bottom line is the same. Any score under 600 shows a creditor that we are a high-risk borrower. A score in the 600s is average. A score over 700 is preferred.
Let's look at the difference a score makes. Although mortgage interest rates fluctuate over time, there is a difference in 30-year fixed mortgage interest rates between borrowers with different scores. For example, if a borrower with a score in the low 500s wanted to purchase a home, the mortgage interest rate could be 9.29%. A score in the high 700s could reduce the interest rate to 6.23%.
Since a credit score can affect our interest rate by as much as 3%, our mortgage payment can end up being hundreds of dollars a month higher. Let's look at this from another perspective. Considering principal and 6.23% interest over a 30 year period, a house could cost about $552,000. The same house at 9.29% interest would cost about $743,000. That difference in interest changes the price on the house by almost $200,000. Imagine what other things we could do with that money!
We should be extremely careful as we make our purchasing decisions. Irrational choices now can end up costing us more than it's worth later.
About this Author
Ozeme J. Bonnette is a financial coach, speaker, and author of Get What Belongs to You: A Christian Guide to Managing Your Finances. After working for a top financial services company, she shifted her focus to speaking to groups hoping to increase financial literacy. She earned 3 Bachelor's degrees at Fresno State, and her MBA at UCLA's Anderson School. Her blog is http://www.povertynorriches.com. Reach her at ozeme@thechristianmoneycoach.com.
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