Time to Read: 7 minutes
Building and maintaining good credit is critical to financial success, whether you’re just getting started or have already accrued wealth. However, we’ve noticed that high-income earners tend to pay less attention to their credit as their net worth grows because they often make more purchases with cash and have less of a need to shop for loans. High tax brackets do not necessarily correlate to high credit scores. Read on to understand why it’s critical to pay attention to your credit score as you make more money, as well as some tips and tricks on how to improve your credit situation even if you’re already a wealthy investor.
What is a credit score, and why is good credit so important?
A credit score condenses your entire borrowing history into one number that lenders use to gauge how likely you are to repay a loan. The greater the score, the less risk you pose to lenders. A high credit score yields more favorable lending terms on a loan, typically in the form of lower interest rates, which in turn leads to smaller payments. Because credit scores extend to mortgages, car loans, credit cards, and many other types of loans, just about everyone benefits from cultivating good credit.
How are credit scores calculated, and what is a good credit score?
Credit scores are calculated and maintained by three different credit bureaus: Experian, Equifax, and TransUnion. Each institution uses variants of a general equation, factoring in payment history, amounts owed, credit mix, credit history, and how often you apply for credit.
Most credit scores range from 300 to 850. In 2019, the average credit score in the US was 703. The general range of credit scores and what they mean are as follows:
- 780 or greater: “excellent” credit worthy of the best terms
- 600–780: “good” to “great” credit, unlocking competitive rates
- 500–600: “fair” credit that banks may view as having a high default risk and thus receive less favorable rates
- 500 or lower: “poor” credit, commonly not lent to at all
How do I improve my credit score?
Credit is like a muscle—the more you exercise it, the stronger it becomes. Below are nine helpful ways to better your score. The first five on the list are the “gold standard” techniques familiar to most people, while the latter four are more clever, opportunistic strategies that will give you an edge in building better credit.
- On-Time Payments – Timing is everything. Pay your bills on time, every time, and never miss a payment.
- Credit History – You have to pay to play, and the longer your credit history, the better. A smart, low-leveraged way to start building credit is to get a credit card early in your life and pay it down each month. It can also make sense to take out a loan for major purchases, like a car, even if you can pay all cash. This may seem counterintuitive, but if you’re financially responsible with deep pockets but never buy on credit, you might discover that you have a marginal credit score when you actually do need to take out a loan.
- Debt-to-Credit Ratio – Try to keep your revolving credit utilization low. A good rule of thumb is keeping a debt-to-credit ratio (the balance you carry on your credit card compared to that card’s credit limit) no higher than 30%. Anything above 30% may be considered suspect to lenders who may flag you as someone who overextends yourself financially.
- Diversify – Banks like diversification. Try to establish a credit history that includes credit cards, auto loans, and mortgages to show that you can handle different types of debt obligations with varying payment terms.
- Debt Avalanche Technique – Strategically pay down debt if you have more than one loan outstanding. For example, if you have two credit cards, focus on paying down the card with the higher debt-to-credit ratio first. Note that this may not necessarily be the card with the highest balance.
- Credit Limit – Call your credit card company every six months and ask them to up your credit limit. That way your credit utilization as a share of the total limit becomes lower and lower over time, even as your spending levels stay the same.
- Timely Reporting – Find out when your credit card company reports to the credit bureaus, and time your payments so they occur right before your usage is reported.
- Plan Ahead – Pay off your credit card bill before you apply for a mortgage or auto loan.
- Outstanding Debt – Call your past banks, lending institutions, and medical providers and make sure you do not have any residual bills left unpaid.
What hurts my credit score?
- Missed Payments – Making late payments is the quickest way to hurt your credit.
- High Debt-to-Credit Ratios – Ratios above 50% may be flagged as cautionary by banks. Maxing out your credit card, which would mean that you have a 100% debt-to-credit ratio, will almost certainly hurt your credit score.
- Minimize Excessive Inquiries – Every time you check your credit score, your score gets dinged slightly, so try not to apply for too many loans at one time. Some soft inquiries are fine; for example, many clients have success using an app like Credit Karma to monitor their scores. If you’re looking for a new home loan, do some research first and shop around before you have the bank run your credit.
- Lack of Diversity – Only using one type of credit may suggest a lack of financial fluency. For example, someone who bought a car, took out a car loan, and paid the loan back on time will have better credit than someone who bought a car with all cash.
- Perils – Significant financial events such as bankruptcy, foreclosure, and short sales can severely damage your credit score. Closing that old Macy’s credit card you no longer use can drop your score too, so it’s wise to keep all cards open if you’re able to do so.
How to help your children build credit
It’s important to provide opportunities for your children to build credit early in their lives. For example, you can introduce them to the concept of credit and teach them disciplined spending habits by co-signing with them on a credit card when they’re in high school. In addition, instead of gifting them a car, help them obtain a car loan and gift them the money for car payments. The financial fluency learned, and responsibility gained, is well worth paying the extra interest on a loan (remember, you can also pay off car loans early). Not to mention, your children will thank you later when they eventually apply for a mortgage and receive competitive rates because of their high credit scores. Bear in mind, credit scores are not transferable, so your high credit score does nothing for your children. The best thing you can do is educate them and foster good habits as early as possible.
What are the benefits of good credit?
Building and maintaining good credit may not be the flashiest of financial matters, but the benefits simply cannot be denied. For example, on a $1 million home loan, the difference between a 3% interest rate and a 3.5% interest rate is an extra $274 on your monthly payment, which translates to an extra $98,000 paid over the life of the loan.
Building credit is fully within your control, making it one of the few guaranteed investments in finance. Moreover, your credit score is unaffected by inflation, interest rates, or any other market movement. So, save yourself easy money and go the extra mile to build and maintain good credit. If you have any questions or would like one of our advisors to review your credit with you, please click here, and we will be happy to start a conversation.
Investment advice offered through Stratos Wealth Partners, Ltd, a registered investment advisor; DBA Brown Wealth Management. Stratos Wealth Partners and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only; and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.