Curious About Credit?
Managing credit and debt can be overwhelming, but understanding the basics can help you take control of your financial future. Kathleen Rushton from Taunton Federal Credit Union shared some valuable insights during the Financial Wellness at Work workshop this month. Here's a recap of the key points she covered.
The Elements of a Credit Score
Your credit score is a crucial number that lenders use to determine your creditworthiness. It typically consists of five elements:
- Payment History (35%) – Whether you pay your bills on time.
- Credit Utilization (30%) – How much of your available credit you're using.
- Length of Credit History (15%) – How long your credit accounts have been open.
- New Credit (10%) – How often you apply for new credit.
- Credit Mix (10%) – The variety of credit accounts you have (secured loans, credit cards, etc.).
How a Credit Score Affects Creditworthiness
A higher credit score demonstrates responsible credit use and makes you more attractive to lenders. It can lead to lower interest rates, easier loan approvals, and even influence whether a landlord will rent to you. A lower score, on the other hand, can result in higher interest rates, costing you more in the long run.
How Credit Impacts Your Budget
Your credit score can have a big impact on your budget. Poor credit could mean higher monthly payments due to higher interest rates.
Unsecured vs. Secured and Installment vs. Revolving Loans
There are different types of loans to be aware of:
- Unsecured Loans: Not backed by collateral (like most credit cards). These typically have higher interest rates.
- Secured Loans: Backed by collateral, like a car or house, often with lower interest rates.
Loans can also be classified as:
- Installment Loans: Paid back in fixed amounts over time (e.g., a mortgage or car loan).
- Revolving Loans: Have a credit limit you can borrow against, like a credit card.
The 5 C’s of Credit
Lenders use the 5 C's to assess your creditworthiness when you apply for credit:
- Credit Score – Your overall credit health.
- Capacity – Your ability to repay based on your income and debt levels.
- Character – Your credit history and how responsible you are with payments.
- Collateral – Any assets you can use to secure a loan.
- Condition – External factors like the state of the economy that may affect your ability to repay.
The Impact of Interest
If you're only making the minimum payments on your credit cards, you’ll be paying mostly interest and perhaps a little toward the principal balance. Over time, this means you could end up paying far more than you originally borrowed. This is why paying more than the minimum is so important.
The 3 Credit Bureaus
In the U.S., there are three major credit bureaus that track your credit:
- Equifax
- Experian
- TransUnion
Each of these bureaus can generate a slightly different score based on the information they have about you, so it's a good idea to monitor all three.
Debt Management Methods: Snowball vs. Avalanche
Two popular methods for paying down debt are the snowball and avalanche methods:
- Snowball Method: Focus on paying off your smallest debt first, then move to the next smallest. This can build momentum and give you a psychological boost as you see debts disappear.
- Avalanche Method: Pay off the debt with the highest interest rate first to minimize the amount of interest you're paying overall.
Both methods can be effective, but which one is best for you depends on your financial situation and motivation.
Let’s Work Together on Your Financial Wellness!
Understanding credit and debt management can be the first step toward achieving financial wellness. Whether you’re interested in pulling your free credit report, figuring out a realistic debt repayment plan, or just have questions, I’m here to help! Feel free to schedule a one-on-one meeting with me to explore these topics further. Together, we can work toward building a solid financial future.
Dora Lima, Financial Wellness Coordinator - dlima@unitedwayiofgnb.org