Why Your Credit Score is the Foundation of Your Wealth

Many, many people have no idea how the credit rating system works. If you’re one of them, then don’t stop reading! 40% of Americans actually don’t know their score, let alone how to even begin understanding their credit score. So if you’re one of them, you’re absolutely not alone.

After all, we don’t learn any of this in school, and we usually only take a look at our score when it’s time to buy a home, take out a loan for a business or make some other type of large purchase.

It’s a shame, too, because your credit score truly is the foundation of your wealth. Understanding your credit score and how to manipulate it to get it to go up is a massive factor that’ll influence your financial future.

But let’s take a step back. First, let’s make sure we all understand what a credit score is, where it comes from, and what’s affecting yours.

What’s a Credit Score?

A credit score is a three-digit number that a lender uses to help them decide whether or not to approve you for a mortgage, credit card, or any other line of credit. So the score is nothing more than a picture of you as a credit risk to the lender.

This means that if the picture of you is poor, meaning that your credit score is low because you’re considered to be not so creditworthy, then you can’t access things like credit cards and good mortgage loans.

Scores range from about 300 to 850, and the higher your score, the better the credit terms you will likely receive.

Keep in mind that we all have credit scores. If you’re married, both you and your spouse have an individual score, and if you apply for a joint loan, both scores will be examined. The riskier it is for the lender, the less likely you are to get approved for a line of credit; or if it is approved, the more expensive the credit will be. In other words, you’ll pay more money in the long run.

Who’s making these scores? There are two major credit scoring models, TransUnion and Vantage 3.0. They look at a few things to calculate your credit score (keep in mind that these are rough percentages; take a look at each credit scoring model for exact figures):

  • Payment history: 35%
  • Debt owed: 30%
  • Credit history: 15%
  • Credit mix: 10%
  • Inquiries (hard inquiries only): 10%

What’s Affecting Your Credit Score?

Payment history is the biggest factor that affects your credit score, but what does “payment history” actually mean?

Payment History

So, what are we actually talking about here? Payment history is a detailed breakdown of how you pay off your debt, including your credit card payments, installment loans, and even your mortgage loan. To calculate your full payment history and credit score, public records and reports that provide specific details such as bankruptcies, foreclosures, lawsuits, liens, judgments, and wage garnishments are also considered.

If you have a history of on-time payments of at least the minimum amount you owe, this is sure to help your score. Likewise, consistently late or missed payments will eventually lower your score.

Amount Owed

Now, let’s talk about the total amount of debt you owe. If your outstanding balances are very high or are almost exhausted on your credit card, it shows that you’re somewhat of a risky person to lend more cash to. This is called your debt-to-credit ratio and will be reflected in a lower credit score.

To ensure that this doesn’t affect you, try to never use more than 30% of your credit card’s credit limit. This means that if your one credit card has a limit of $10,000, never spend more than $3,000 on that card in a month.

Length of Credit History

What about the length of time that you’ve had certain accounts? Basically, lenders want to see that you’re able to responsibly manage your credit for a long period. This means that if you’re younger, you might find it hard to bulk up this portion of your credit score. To combat this, we suggest asking to be an authorized user on someone else’s card.

Credit Mix

But, don’t just think about credit cards when building your credit. You need to think bigger! Or at least more diverse. This is because credit mix is another factor affecting your score. Although it’s not necessary to have every type of account, having a good mix of accounts shows that you’re responsible enough to manage them all.

Hard Inquiries

And, finally, hard inquiries might be affecting your score. A hard inquiry is when you ask a creditor to pull your credit report. Why is that a bad thing? It implies that you’re looking to acquire more debt, which indicates some level of risk.

What's more, opening too many short-term credit accounts is very risky. It’s best to avoid too many hard inquiries unless you absolutely have to make one, because, hey, sometimes it’s unavoidable.

Example: Good Credit Could Save You Over $60,000 on a Home Loan

So, you know what a credit score is and what affects your credit score. But still, how does this all relate to you building wealth? Your credit score will mostly determine the types of loans you’re able to access and the interest rates you’ll have for each loan. When building wealth and investing in assets such as properties, this is super important.

It’s easier to understand the effects of your credit score by looking at real-world examples, so let’s start breaking it down.

Let’s say you decide to borrow $200,000 in the form of a 30-year fixed mortgage loan. If your credit score is in a higher category, let’s say between 760-850, a lender can charge you 3.307% interest on that loan. That equals a total payment of $877 per month.

Now, let’s say that your credit is lower, between 620-639, for example. A lender now might charge you 4.869% on that loan. While this might not seem like that much of a difference, your monthly payment would now be $1,061. 

That’s the difference of $184 in savings per month and a total of $66,343 in savings over the lifetime of the loan!

Learn to Manage Your Credit

In short, you have to learn to manage your credit if you’re looking to build and compound your wealth. 

Excellent credit management will lead to a higher credit score, leading to reduced costs when borrowing money to build more wealth. Living within your means, managing debt wisely, and paying all your bills, including minimum credit card payments on time, are always considered very smart financial moves for those interested in credit building.

Need a more in-depth look at how this relates to you building wealth? Download the Wealth Stack app for free on the App Store or on Google Play. There, you can start learning through our helpful (and free) video courses.