To some students, credit scores may end up saving or costing tens of thousands of dollars, while to others they may mean nothing.
A credit score is a tool used by lenders, creditors and other organizations to evaluate how “creditworthy” an individual or family is, which in turn determines the terms of loans, leases, some employment opportunities and many other financial mechanisms as detailed below.
What are the downsides of having a low credit score?
A landlord may refuse to offer a prospective tenant a lease out of fear he or she will fail to pay rent. When applying for a loan for a major life purchase, such as a car or a mortgage on a house, banks may charge higher interest rates and require a larger down payment in order to mitigate the risk of loaning. A poor credit score can even deny entry to the armed forces or application for a security clearance.
“Some employers — particularly financial services firms — might check an applicant’s credit score during the interviewing and hiring process,” James Philpot, personal financial planning professor, said. “The logic here is that people with better credit are less likely to get into financial distress, and thus less likely to steal from the firm or customers.”
Several credit reporting agencies are analyzing your financial decisions and reporting them to other companies who may or may not help you with major financial moves later in life.
If maintaining a credit score is a priority, let’s examine the determinants of the score to find what actions are relevant to current college students.
The financial services company Wells Fargo gives a breakdown of five key factors in order of decreasing weight. The first two factors, your credit payment history and debt-to-credit ratio, can be managed by simply paying your debts on time and having as little debt as possible.
“30% is the ideal number to keep your debt-to-credit ratio at. So, if you have a $1,000 credit limit, try to stay under $300,” Eric Schmidt, MSU alumnus and current credit department manager at Springfield First Community Bank, said.
The third factor is the age of your credit accounts. This may not be actionable immediately, but the easiest way to get a head start is by getting a credit card from your bank soon after reaching age 18.
The next two factors usually revolve around significant financial decisions. When an organization runs a credit check, they’re able to see how many other organizations have done so recently. This is known as a hard inquiry. These don’t permanently affect your score but may raise concerns and lower your credit in the meantime.
Lastly, having multiple types of credit accounts raises your credit score by showing that you’re consistent in more ways than just one. An example of this is successfully maintaining a line of credit for a car loan in addition to a credit card.
To summarize the complicated factors that go into a credit score, let’s consider two hypothetical students: responsible Rufus and beach bum Billy, both of whom have just graduated from college.
Rufus has had a credit card since the age of 18 and a small car loan since the age of 20 and has dutifully made payments on schedule every single month. Though his credit card limit is $2,000, his balance rarely exceeds $500. A credit check was run on him two years ago when he applied for an apartment, but none have been run for him recently.
Billy rocked out on a debit card and cold hard cash until he turned 20. Within a few months, he obtained a credit card, maxed it out and failed to make a payment on time. All of a sudden, three car dealerships, two apartment leasing agencies and a government agency evaluating him for a security clearance all run credit checks on him.
Ask yourself these questions: which student is more likely to successfully apply for a small business loan? If both succeed, which one would require a higher interest rate, higher down payment and a cosigner for the loan? If you haven’t already begun looking into building your credit, this semester might be the time to start.