Your credit score can be an important component of your financial planning. While it's possible to make it through life without ever taking out a loan, most people can't afford to buy a home or pay for college with cash. A good credit score can help you take on an affordable loan to tackle these large expenses. Your credit score can also be an important indicator of financial health. Here are three ways your credit score might be affecting your retirement readiness.
1. Low credit scores are often a reflection of too much debt. Debt is the number one roadblock to a comfortable retirement and one of the leading causes of a poor credit score. Your credit utilization ratio, the amount of debt you have versus the amount available on your credit limits, makes up 30 percent of your credit score. Too much debt affects your cash flow and takes money away from other important goals, such as contributing to retirement accounts and investing. Reducing the total amount of debt you have not only improves your credit score, but, more importantly, improves your cash flow and financial health.
2. A low credit score means you pay higher interest rates. If you have a poor credit score and need to take out a loan for a mortgage or other big ticket item, you can expect to pay hundreds and perhaps thousands more over the life of the loan than if you had a high credit score. Improving your credit score means you can qualify for lower interest loans and better mortgage rates and use those savings for more important things like opening a Roth IRA or funding your 401(k) plan.
3. Your credit score can affect your ability to get a high paying job. Some employers use credit scores as a screening tool to help them determine which job candidates are most trustworthy. These companies believe your credit score can be a reflection of your ability to handle money and therefore your trustworthiness. Several states have proposed legislation that would prohibit this action, but for now this is a real threat for many job seekers. Improving your credit score may help you land a higher paying job. You can use the additional income for more important things, such as paying down debt, investing for retirement, and having fun.
Steps to take. Improving your credit score will help you in many aspects of your financial life. Here are some ways you can improve your score.
- Understand how your credit score works. The first step is understanding how your credit score is calculated.
- Make on time payments. Your payment history makes up the largest percentage (35 percent) of your credit score.
- Pay extra on your loans. Your credit utilization makes up 30 percent of your credit score. Paying extra on your loan reduces your credit utilization and decreases the amount of interest you pay and the time it takes to become debt free.
- No new lines of credit. The average age of your credit accounts and the number of lines of credit you have open affect your credit score.
- Time. Follow these steps and practice good credit habits and you will see your credit score climb.
These steps require time and discipline, but they are worth the effort. Understanding how your credit score works and improving your score can put you on a successful financial path to retirement.