“Glass, china, and reputation are easily cracked, and never well mended – Ben Franklin.
Trust plays a fundamental role in credit transactions, and a borrower's reputation is a significant component of this trust. Creditors assess the borrower's reliability based on their reputation when deciding to extend credit. This reputation gives the creditor a sense of surety regarding the borrower's behavior, including faithful debt repayment, punctual payments, and compliance with the agreed terms. However, even minor deviations from these agreed terms can swing the creditor's expectations from certainty towards uncertainty, which translates to risk. As such, a borrower's past credit history, reflective of their reputation, is highly regarded by potential future creditors when deciding on credit extensions.
The Drivers of Your Credit Score
Credit usage shows how much you spend on your credit accounts (credit cards and HELOC) as a percentage of your total available balances (your credit limits) for all your credit accounts. A high percentage could indicate that you don’t have your spending under control and could be at a greater risk of defaulting on your payments. Try to keep your credit usage under 30%.
Payment history plays a critical part in determining your score. Making your payments on time shows potential lenders how reliable you are in paying back what you owe. Be sure to make all your payments on time (even if it’s just the minimum payment due), and remember that other types of credit payments, such as those for student loans and auto loans, also affect your score.
Age of credit is the average amount of time you’ve had all your open credit accounts. It measures the longevity of your credit history. Opening several accounts in a short period may indicate an elevated level of risk, so avoid opening lots of credit accounts unless you need them. Keep your old accounts open and provide a good payment history for each.
Total accounts are your number of accounts, which may indicate how credit-worthy lenders think you are. Do not open more accounts than you need because the average credit age is more significant than the number of accounts when calculating your credit score.
Credit inquiries count all hard credit inquiries placed on your credit report. What makes an inquiry “hard” is when you authorize a lender to get your credit report for their benefit so they can evaluate you when you apply for a credit card, a loan, or other form of credit. If you get your credit report via credit agencies (or similar agents), it’s called a soft inquiry, and it does not affect your credit score.
Derogatory marks are indications of poor behavior in the past when it comes to being responsible for credit. These include accounts in collection, liens, and bankruptcies – things potential creditors are wary about. Sometimes, things like this happen and are beyond your control, but if you can, do your best to keep these things from happening. No matter the reason, these negative marks will likely stay on your credit report for seven years or more.
Credit Categories and the Impact on Consumers
According to the Consumer Financial Protection Bureau’s 2023 Consumer Credit Card Market Report, the credit approval rate for superprime and prime plus is 86% and 79%, respectively, compared to near-prime, subprime, and deep subprime, which are 41% and 17%, respectively. This means that someone with superprime or prime plus would be 2-4x more likely to get approved for credit.
This same report showed that annual effective interest rates for subprime and deep subprime consumers are 22% and 23%, respectively. Compare this to superprime and prime plus, where annual effective interest rates are 9% and 15%, respectively. This means that someone with poor credit could be paying up to 2.5 times the interest rate of someone with excellent credit.
Conclusion
Your credit score, like your personal reputation, reflects your financial trustworthiness. Factors like credit usage, payment history, credit age, total accounts, credit inquiries, and derogatory marks can influence your score. Higher credit scores increase your likelihood of credit approval and could potentially lower interest rates, saving you money in the long run.
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Walnut Hill Wealth Management, LLC (“WHWM”) is a registered investment advisor offering advisory services in the State of Texas and in other jurisdictions where exempt. The information provided is as of the date indicated and is subject to change.
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