The Best Investment You Have: Your Credit
When it comes to investments, there is no end to the commentary about the best ways to do it. Often there is substantial risk. But that isn’t always the case. In fact, there’s one portfolio that could be the deciding factor on whether you go on that family vacation, buy a new car or retire early — and it requires no capital at all.
The portfolio I’m talking about is not affected by daily stock market fluctuations. In fact, it tends to grow slowly. That said, it is very predictable and the return on investment — if you truly manage it well — is excellent. I am talking about your credit portfolio.
At first glance, it may seem like a gimmick, but anyone who’s ever shopped around for a loan knows that all loans are not created equal. Good credit makes for cheaper money. The amount you have to pay an institution to use their money can range from a few easy-to-pay percentage points to double-digit woe.
The reason the price of money can be so variable is simple: lenders use your credit portfolio to figure out how much of a risk they can take on you with their money. They want to get paid back, and your credit is the way they determine how likely you are to do that.
Credit is a grow-able asset. There are specific things you can do to make it grow, just as there are things you can do (and not do) to make it wither and die. Everything you do provides lenders with a picture of what kind of financial creature you are. To make the right impression — one that makes you look like a good risk — there are five factors you must manage.
1. Payment history: This accounts for 35% of your overall credit score. Put simply, pay on time. The rewards far outstrip the inconvenience of having a little cash at the end of the month. And after all, as long as you have debt, you’re just renting that money.
2. Credit utilization: This is a fancy way of saying “how much you owe”. For the best score you are going to want to keep your credit-to-debt ratio under at least 30% and ideally 10%. This accounts for 30% of your credit score.
3. Age of your credit: Your credit age accounts for 15% of your overall score. The more information that the banks have about you, the more they can feel comfortable when you’re walking around with their money — or driving around in it, or sleeping in it, etc. Refrain from closing accounts after paying down a big balance. It can negatively impact your score.
4. Credit Mix: Just like a traditional investment portfolio, your credit score will improve if you spend some time diversifying. Having a car loan, a mortgage, credit cards and other kinds of credit help provide banks with a better idea of how you financially manage a complex household. Your credit mix accounts for 10% of your score.
5. New credit/inquiries: If you open several lines of credit during a short window of time, it sends a bad message to the banks — you’re hoarding. It’s a big red flag. Always approach credit use with moderation. Applications for new credit account for 10% of your score.
The above factors all matter, and credit is not something that grows by leaps and bounds, but if you treat it right, it won’t fail you. (You can see where your credit currently stands by viewing your two free credit scores each month on Credit.com.) And the savings that you will reap can be substantial. Here are some areas where maintaining a strong credit portfolio can save you money, and increase your net worth.
1. Home Mortgages
The better your credit, the lower your interest rate. This translates to lower monthly payments. It may also mean that a bank is willing to lend you more money than they would someone who has a weaker credit score.
2. Car Financing
The same is true with cars. The better your credit score, the better deals on leases and financing will be available to you. And remember, when you have a good credit score, you are literally in the driver’s seat. Banks will compete for your business. So, don’t settle for the first offer. Bargain!
3. Seasonal Purchases
Making seasonal purchases in the off-season can be a great way to save money, and if you have strong credit and a credit card, you may have some extra time to purchase end-of-season items and sock them away for next year. Just be sure to pay your balances off by the end of the month.
4. Renting a Home
The better your credit, the better your chances of getting that perfect house or apartment and negotiating terms. Landlords are always looking for low-risk tenants, and credit is one way they make decisions.
5. Getting a Job
Some employers will need to check your credit before making you an offer of employment. This is more common in financial services employment, but it happens elsewhere, too. Bad credit is a lousy reason not to get a job.
Credit can be a life changer — for better and worse. Used correctly and managed wisely, it is an investment that can mean a richer, more productive life.
Adam Levin is co-founder of Credit.com and IDT911. His experience as former director of the New Jersey Division of Consumer Affairs gives him unique insight into consumer privacy, legislation and financial advocacy. He is a nationally recognized expert on identity theft and credit, and is the author of SWIPED: How to Protect Yourself in a World Full of Scammers, Phishers, and Identity Thieves, a practical, lively book that is essential to surviving the ever-changing world of online security. More by Adam Levin