My credit score: A love/hate relationship

Screen shot 2009-12-09 at Dec 9, 2009, 10.37.26 PMWhat’s that saying? Oh that’s right, “Damned if you do and damned if you don’t.” I’ve never really had a reason to use this phrase before, but when it comes to my FICO score, it is the first thing that comes to mind. The only way to have a high FICO score is to continually be borrowing money. This causes a problem when your blogs name is Punch Debt In The Face. How can I possibly strive to have a high FICO score, but swear off virtually all debt? Unfortunately, I’m not sure I can answer that question, but I’m gonna give it my best shot.

For those that don’t know, your FICO score is basically a measure of how likely you are to repay your debts. A high FICO score, means you will probably make most payments on time, with few (if any) hiccups. A low FICO score, indicates a high probability you will make late or no payments rather frequently.

There are five main categories that make up each individuals FICO score…

* Payment History (timliness of repayment)
* Amounts Owed (available credit compared to credit used)
* Length of Credit (length of time you’ve had the account)
* New Credit (how frequently are you opening new accounts)
* Type of Credit (student loans, car loans, credit cards, etc)

Now that you know the components of your FICO score, lets talk about why it’s important. I assume most of my 20 something readers are like myself and  hope to one day purchase a home. I would also assume most of us plan to take out a loan to purchase said home (if you are planning on paying 100% cash, you need not continue reading).

Did you know your FICO score plays a huge factor in your ability to purchase the home of your dreams. Let’s run through a little hypothetical situation…

Johnny has a terrible credit score and walks in to his local bank to apply for a $200,000 mortgage on his dream home. Ninja also walks in to the same bank to apply for a $200,000 mortgage, but Ninja has a very high credit score. There is a good chance the bank is going to reject Johnny’s application, therefore crushing his dreams of being a homeowner. But let’s say they don’t. Let’s pretend they decide to qualify Johnny for that loan. The bank gives Ninja a low interest rate of 4.75% because he is not a risky person to loan money to. With Johnny however, the bank has taken on some risk by giving him a loan, so they decide to charge him an interest rate of 6%. Ninja’s total interest paid over 30 years is going to be $175K, meanwhile Johnny’s going to have paid over $230K in interest. That’s a $55K difference for taking out the same loan from the same bank. High credit scores generally result in better financing options.

Here’s the problem. The only way to have a high credit score is to be continually borrow money. You’ll notice all five components of the credit score require you to have credit available to you (aka you have to be in debt). What if you are like me and have sworn off incurring future debt, except for a mortgage, and are aggressively working to get rid of all current debt? Fortunately there is at least one way to continually be “borrowing” money, without actually being in debt.

I use my credit card for every purchase I make. By the end of each month, my balance is usually around $1,500. I then pay off this balance in full, so I incur no interest charges. My CC company will then report this information to the credit agencies. Since I made my payment on time, my credit score is going to continue to increase. It’s a simple, yet effective way, to raise your credit score, without having to pay for it.

This is the only free way to raise your credit score I know of. Does anyone else know of other ways to raise your credit score without going in to debt? Let me know ’cause I’d be very curious to hear them! At the end of the day I really wish credit scores didn’t exist, but the reality is they do, and they are frustratingly important.