Why Your Credit Score Matters

How much do you know about your credit score? That three-digit number is tied inseparably to our financial lives, yet many young adults haven't given it the attention it deserves. Your score can play a role in your ability to rent an apartment, qualify for a loan or even get a job. It can also affect how much you'll pay on interest charges, insurance and even cell phone contracts.

Make building a stellar score a priority while you're young and you could actually save hundreds or thousands of dollars over your lifetime. However, if you don't take your credit seriously, a bad score -- or even a nonexistent score -- will cost you.

Who's keeping score?

Your credit score is basically used to predict the possibility that you won't pay your bills. They are compiled by Fair, Isaac & Co., and are sometimes called FICO scores. The top possible number is 850, but topping 800 is probably unrealistic. A median score usually falls in the 720-to-725 range, meaning half of consumers fall above that point, half below. Even if you haven't given your FICO score much thought, there are plenty of others who have or will, so you'll want to aim for the mid-700s to make the best impression on:
 1. Lenders. This group is the one most people associate with their credit score. Having a good rating can help you qualify for the best rates on a mortgage, car loan, credit card and even a small business loan if you've got that entrepreneurial spirit. A nonexistent score can make it impossible for you to qualify for a loan or credit card at all. (Learn how to overcome this obstacle below.)

2. Insurers. The majority of auto insurance companies use your credit score when determining your rates, and the practice is also common among home insurers. A recent survey by Consumer Reports among eight popular auto insurers found that drivers with top scores could pay up to 31% less on their premiums than if credit scoring wasn't factored in, while those with bad scores would pay as much as 143% more.

3. Landlords. Increasingly, you may need a good credit score to rent an apartment. Landlords view your credit rating as a measure of your responsibility to pay bills on time. If your rating is below par or you don't have a credit score yet, you may have to find a friend or relative to co-sign your lease, or you could be required to pay a higher rent or security deposit.

4. Employers. When you're applying for a job, potential employers can pull your credit report as long as they notify you first. And, in fact, about 35% of them do, according to the Society for Human Resource Management. Why? Bad credit can be a signal of irresponsibility, or employers might be worried you'll spend more time fretting about your financial woes than concentrating on the job.

5. Cell phone carriers. Even cell phone service providers may check your credit before signing you up for a plan. They want to make sure you're responsible and will pay your bill each month. Some utility providers may pull your report as well. If you have credit issues, you may not qualify for the best plan rates, you could be required to pay a deposit, or you could get turned down.

True cost of your score

So, how much does your credit score affect your finances? Say we have two friends, Jim and Mark. Both took steps right out of college to start building a credit report by getting their first credit cards and an auto loan. Jim made all his payments on time, never maxed out his credit cards and often paid more than the minimum required. Mark, however, frequently paid late, overextended his cards and applied for new credit to bail him out of his mismanaged debts.

Now both are ready to buy homes, and they each apply for a $250,000 30-year mortgage. Through Jim's responsibility, he's been able to build a score of 750, qualifying him for a loan with a 6.2% interest rate, according to Fair Isaac, a credit scoring bureau. Mark's score comes in around 650, netting him a rate at 7.3% interest. Jim's monthly mortgage payment is $1,536 while Mark pays $1,718 -- a difference of $182 per month. If they both live in their homes for ten years before selling or refinancing, Mark will pay $21,840 more in monthly payments than his friend. Ouch.

Mark also gets burned on a new auto loan -- paying $1,332 more over three years on a $20,000 loan than Jim. Plus, Mark probably paid much more for his car insurance than Jim.

How to get started

Even if you don't plan on applying for a loan, or getting a new apartment or a new insurance policy anytime soon, it's a good idea to start building your credit score now so it's there when you need it.

When you're starting from scratch, a good place to begin is in college where lenders hand out credit cards like candy. But don't rush to indulge. Janet Bodnar, Kiplinger.com's Money-Smart Kids columnist, advises students to get just one card their junior or senior year, use it occasionally and pay off the balance each month. It's much easier to qualify for a credit card while you're in school than after you graduate (lenders figure that Mom and Dad will bail you out while you're in college if you can't pay your bill).

If you're already out of school, or you don't trust yourself with a full-fledged credit card yet, a secured card will help you get off on the right foot. This card allows you to make a deposit with a lender (such as your bank or credit union), and the amount usually becomes your credit limit. The issuer takes on zero risk because if you don't pay on time, it can dip into your account to cover the bill. Most issuers require a deposit of $300 to $5,000. You build a history just as fast with a secured card as with a regular one. And after making payments on time for a year with a secured card, you should have an adequate history to switch to an unsecured card and get your deposit back.

A new scoring system from FICO may soon help young adults trying to build a credit history. It is based on alternative data such as whether you pay your electric bill on time and maintain a clean checking account (learn more.) So you'd do well to keep all areas of your finances in tip-top shape.

Boost your score

Knowing what goes into your credit score can help you manage your debts well. Here's how to make the best impression on your credit history:
  • Pay on time. 35% of your score depends on your payment history.

  • Don't max out your cards. 30% of your score is based on how much you owe. You want to keep your "credit utilization" ratio -- the percentage of your credit limit that you've actually used -- no higher than 30% of your available credit limit.

  • Start while you're young. 15% depends on the average age of your accounts.

  • Avoid opening several accounts at once. Not only will this lower the average age of your accounts, but lenders will worry that you might go on a borrowing binge. 10% of your score depends on new credit.

  • Get the right kind of credit. This accounts for the final 10% of your score. Your experience with revolving credit, such as credit cards, on which you control how much you charge and pay off each month, carries more weight than installment debt, such as car loans and mortgages, with fixed payments. But don't simply stock up on a pocketful of Visas -- lenders like to see that your money skills are well rounded.

    source: kiplinger.com