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Where does a credit score come from?
Credit scores are the numerical translation of your credit report. It takes
all of your information, such as the number of credit lines you have. And how
you have managed them, and assigns an overall number (between 300 and 850, the
higher the better) that tells a lender how likely you are to repay a loan on
time.
How
does the FICO system work?
FICO is a risk assessment system developed by Fair Isaac and Company that tells
a lender how likely you are to repay your debt. Under the FICO system, there
are five major categories that make up a credit score.
Payment
History (35% of Score): This keeps track of whether you have been making your
payments on time.
Amounts
Owed (30% of Score): This looks at what is owed to whom.
Length
of Credit History (15% of Score): A longer, positive credit history will increase
a score.
New
Credit (10% of Score): Opening several new accounts or having many inquiries
into your credit history in a short period of time will affect your chances
of qualifying for credit.
Types
of Credit Used (10% of Score): If you have a lot of lenders who are classified
as “D” or Subprime lenders, you may be placed in a high-risk category,
even if your payment history is perfect.
How
many credit reports are kept in your name?
There are three. Each of the major credit reporting agencies, TransUnion, Experian
and Equifax, tracks your credit history.
How
long does negative information stay on your credit report?
Negative information remains on your credit report for seven years. After that
time, it should be removed to give you a fresh start.
What
do you think is a good credit score?
A good credit score is in the range of 750 and above.
Can
you be denied a job if you have bad credit?
Absolutely. Many more employers are beginning to rate job candidates based on
their credit scores.
Can
bad credit affect your car insurance?
Over the last few years, insurance companies have begun using peoples credit
history to determine their premiums. Also, an insurance company may discontinue
coverage should an individual’s credit become poor during the term of
the policy.
What
is the relation between risk and return?
There are many ways to save money and build wealth, some of them riskier than
others. The more risk, the more potential you have to build wealth (return).
As an example, let us compare two ways to make your money grow: a savings account
and a stock. A savings account has very little risk; the money you put into
it is insured by the FDIC and you have very little chance of losing your money.
On this type of account, you would probably earn about 1.5% interest. Stocks,
on the other hand, are very risky. There are a number of factors that could
cause you to lose your money in the stock market. Because of the high risk,
over time you would probably earn an average of between 10% and 11% interest
on your original investment.
How
much money should you have in savings?
You should save at least 10% of your net income (take home pay) each month.
Ultimately you should build a financial cushion equal to 3 to 6 months’
worth of your regular expenses.
How
much money do you think you will need to retire?
Many experts recommend that set aside 80% of your annual net income for each
year of retirement. If you normally live on $40,000 a year, theoretically you
would need $32,000 set aside for each year of retirement. If you retired at
age 50 and lived to be 85, you would need about $1,120,000. Of course, it’s
not as cut and dried as that. You have things such as inflation you’ll
have to deal with. (Inflation is when the prices of goods and services rise.)
Historically, inflation has grown at a rate of 3% each year. For example: if
you bought a soda today for $1, next year that soda would cost you $1.03; in
ten years that soda would cost you $1.30.
Each
year of retirement, your money will be worth less as the prices for goods and
services increase. For this reason, it’s always good to plan to save much
more than you actually think you may need.
How much money do you think you need to start investing?
You can start investing with as little as $50 a month. You should contact a
financial planner to see how to get started.
What
is a debt-to-income ratio?
A debt-to-income ratio is often used to determine whether you are carrying a
“safe” amount of debt. Creditors look at a debt-to-income ratio
to compare your income with your expenses. This tells them whether you have
too much debt.
The debt-to-income ratio is represented as a percentage. It is a representation
of your monthly debt payments vs. your gross monthly income.
The
first step in calculating your debt-to-income ratio is to figure out your gross
monthly income (before taxes). Include income from additional sources as well,
such as scholarships, loans, and cash from your parents.
Next,
list the current minimum payments on all credit cards and loans. Be sure to
include:
• Car payments and other installment loan payments
• Bank/credit union loans
• Credit lines
The
debt-to-income formula is: monthly debt payments ÷ gross monthly income
Example:
Monthly debt payments = $700, Gross monthly income = $3,200. Debt-to-income
ratio = 700 ÷ 3200 = .218 (round up to 22%). Note: To get a percentage,
multiply 0.218 by 100. This would be 21.8%. Round up to 22%.
How
much of your income should you pay toward your debt?
For many of us, getting out of debt is an important goal. An equally important
goal should be building savings, since emergencies do arise and it is important
to have a financial cushion to help you get through difficult times.
Normally,
we recommend that you put no more than 15% of your net income toward your unsecured
debt payments. However, if you are saving 10% of your income, and you can afford
to do so, you may exceed the recommended parameter.
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