In the realm of personal finance, few metrics carry as much weight as your credit score. It's the key that unlocks favorable interest rates, optimal loan terms, and a pathway to financial opportunities. For those who work in creative fields, often running their own businesses or as a freelancer, maintaining a good credit score can be crucial when facing common problems like inconsistent cash flow. Use this 5-step guide as a roadmap to really understanding credit and ways you can use credit toward your advantage in your personal and professional life.
Step 1: Demystifying the Credit Score
To master the credit score game, it's essential to start at the beginning: understanding how credit scores work.
More than a number
Your credit score is a numerical representation of your creditworthiness, ranging from 300 to 850 in most scoring models, FICO being the main one used. When it comes to the score, a good threshold is 720. 720 is considered a solid credit rating and serves as a threshold in some lending programs. A score below 600 can make it extremely difficult to secure credit and receive favorable interest rates and lending terms.
Your credit score is calculated using the following factors: payment history, credit utilization/amounts owed, length of credit history, types of credit in use, and new credit accounts. Understanding these components is the first step towards taking control of your financial destiny.
Focus on your habits more than anything
I’ll share a little secret with you creditors don’t really look at your exact credit score. The first thing a creditor will look at is your payment history, which accounts for 35% of your total credit score. I know this first-hand as a mortgage loan officer helping people secure mortgages and through having underwritten loans myself.
Timely payments on credit accounts demonstrate a consistent ability to meet financial obligations. And for entrepreneurs and those in freelance or creative fields, before you can even think about business credit, your personal credit needs to be solid.
Step 2: Building a Solid Credit Foundation
With a foundational understanding of credit scores, it's time to move to the practical steps of building a solid credit history.
Debunking the myth that debt is bad
Responsible and strategic use of debt can be a powerful tool for wealth-building and financial growth. And for business owners, especially if you’re a small business owner or a new one, personal credit may be the only way to get the financing needed to grow. Leveraging debt wisely, such as using low-interest loans for business expansion, can contribute to wealth creation.
Photo by: Alice PasqualResponsible Credit Card Usage
As of 2023, it’s been reported that 79% of consumers own at least one credit card or charge card. Credit cards can be powerful tools for building credit when used responsibly. Using credit cards strategically can offer multiple benefits, starting with the opportunity to build a positive credit history. Additionally, many credit cards come with perks such as cash-back rewards, travel miles, and purchase protection.
Diversifying Your Credit Portfolio
Creditors appreciate a diverse credit portfolio. When building your credit, it’s important to have a mix of credit types, like having both credit cards and installment loans (installment loans include personal loans, mortgages, and student loans among others). By diversifying your credit usage, you can showcase your ability to manage various financial responsibilities, positively influencing your credit score. For business owners, often this mix of credit is a must to manage operations.
Step 3: Navigating the Credit Report Terrain
Your credit report is the foundation upon which your credit score is built. Navigating this terrain is crucial for ensuring accuracy and rectifying any discrepancies.
Obtaining Your Credit Report
The three major credit bureaus are Equifax, Experian, and TransUnion and each of them now offers free credit reports every week, providing individuals with more frequent access to their credit information. Understanding the information contained in your report is fundamental to identifying areas for improvement and ensuring the accuracy of your financial history.
Photo by: Kelly SikkemaIdentifying and Correcting Errors
Errors in credit reports are not uncommon. Look for discrepancies such as accounts you don't recognize, incorrect payment statuses, or inaccurate personal information. Report any discrepancies promptly to the respective credit bureau, providing supporting documentation to facilitate the correction process and ensure the accuracy of your credit report.
Step 4: Strategic Steps for Credit Score Enhancement
Life is unpredictable, and financial setbacks can impact your credit score. In this step, we'll explore effective strategies for credit score improvement.
Overcoming Setbacks
If you've faced financial challenges, all is not lost. If you become delinquent on an account, begin by contacting the creditor to discuss your situation and explore potential solutions, such as setting up a repayment plan or negotiating a settlement. Additionally, consider negotiating with the creditor to update the account status on your credit report, potentially reflecting it as "paid" or "settled" rather than delinquent.
Side note: be careful with credit repair services who often claim they can "fix" your credit score and clean up your credit, as many use fraudulent practices and creditors can often see this directly. In my work as an underwriter and a loan officer, I have experienced consumers falling victim to credit repair scams too many times.
Monitoring Your Progress
Regularly monitoring when payments are due is essential for maintaining a positive credit profile. Additionally, keeping a close eye on the balances you carry about your credit limit is crucial. Aim for usage at 30% or less of your credit limit. Regularly reviewing these aspects of your credit management allows you to make informed decisions, avoid potential late fees, and ensure a positive impact on your overall creditworthiness.
Photo by: Kostiantyn LiStep 5: Sustaining and Growing Your Credit Score
Maintaining a high credit score (secret: you really just need to focus on a clean report with on-time payments and balances that are not too close to credit limits) requires ongoing effort and planning for the future.
Responsible Financial Habits
Discover the habits that contribute to a positive credit score. From paying bills on time to managing your overall financial health, these habits are key to sustaining a high credit score. Consider creating a budget for yourself to manage your spending habits. The rapper and business mogul Jay-Z had a good word of advice on this topic, famously stating that if you can’t purchase the item in question twice, then you can’t afford it.
Planning for Financial Milestones
Your credit score is a lifelong companion on your financial journey. When it comes to preparing for life’s big moments such as buying a home or vital equipment for your business, your credit history will be the deciding factor in your ability to not only be able to secure these types of debt but to ensure you receive favorable terms. The more favorable terms you receive, the more money you will save!
Conclusion: Empowering Your Financial Future
Your credit score is not just a number; it's a reflection of your financial habits and decisions. Taking on the right kind of debt can actually serve as an asset to your financial well-being and can be necessary at times, particularly for those who are investing in and/or managing a business. Your credit is one of the most powerful assets you have when it comes to financial empowerment so don’t be afraid to use it; just use it wisely!