Credit Score Management

Associates, we're going to talk about an important subject right now, and that is your credit score. Now, this is important because as you come out of dental school, you've just got done taking on a bunch of debt. Yes. But guess what? You're most likely going to have to take on a lot more debt. And it can feel overwhelming and intimidating. But that's okay, because a lot of the debt that you're taking on, your student debt, your practice debt, eventually your home debt, that's what I call good debt. Because it's debt that's going to create wealth for you over time or financial security for you over time. It's not like you're going to a department store and paying way too much money for a big basket of clothes or even too much of a car. That's all going to lose its value over time while you're still hanging on to the debt. That's not what I'm talking about. Obviously, you need to avoid that. We are managing our credit score here so that you can be lendable. So a bank looks at you and says, I would actually like to lend to this doctor because I believe that they're going to pay me back over time. And the number one factor that they use is going to be your credit score. Now, credit score isn't perfect. It is a commoditized numerical value of what lenders look at when determining your credit. Now, it's way better than 40, 50 years ago when they didn't have a number to compare people's credit abilities. Apples to apples. At that point, it was just, what do they know about you? And it was a very personal level. But now we have this credit score which has made everybody a walking numerical value that banks can look at and easily determine whether they're going to lend to that person or not. So inevitably, you have to face the fact that your credit score really matters because. Because you're in a career field where you're going to have to take on more debt. And if you want to own a house, you're going to have to take on more debt. So let's talk about this credit score. The credit score is calculated with five different elements of your financial behavior. Payment history, amounts owed, length of credit history, credit mix, and your new credit. And I want to talk about all five of those. Take a minute or two on each of those. But before I do, let's. Let's just look at the makeup of maybe people in general, Americans in general. How's our credit score? Well, according to Experian, now This may be a little optimistic in my opinion, but according to experian, we have 21% of people have 800 or better. Now, I haven't met that many people who have 800 or better, so I'm a little bit skeptical about that. But they're saying 21%. Now, Experian, you may, by the way, be asking, who is Experian? Experian is one of the three credit bureaus. There's three credit bureaus, Experian, Equifax and TransUnion, that tracks everything about you financially, which is then used by lenders to determine whether they want to lend in to you. They provide you a credit report that shows all your debt history and your payment history. I'm going to talk about that. So Experian put this together. They said 25% are very good, 21% are good. And then you get 17% are fair and 16% are very poor. According to them, 67% of Americans have a good FICO score. Now, this may be a little outdated too, but that's what they're stating. Now, where do you need to fall on that pie chart in order to receive a practice loan when that time comes? Well, what the bankers are looking for in associates in a practice acquisition loan is generally 670 or above. Now, different banks have different requirements on that, but generally it's somewhere in the upper 60s that they want to see as a minimum notice under the 740 to 799. The very good section says applicants with scores here are likely to receive better than average rates from lenders. Now, that is true. And I don't want you to be shooting for 670. No way. I want you shooting for a 740 or above, maybe even get close to upper seven. Upper seven hundreds. Admittedly, that's going to be hard because many of you don't have a long credit history and you haven't taken on a whole lot of debt besides your student, your student loans. And so you don't have much, what's called a credit mix, which we're going to talk about. And so it might be a little bit hard to get up there, but I do believe it's very possible and not even terribly difficult to get around the mid-70s. 737, 740, you can do that, no doub. And that's really going to help when you get to that point where you're asking a bank to lend you $800,000 or $1.2 million or $1.8 million or $500,000, whatever that is going to be very helpful. Let's talk about now those five different elements of what makes up your credit score. The first one, and the most important is simply your payment history, which simply means have you been paying your debt on time or over the years? It is the strongest predictor of future payments that will be made on time. So that's why they look at that, because statistically they've shown that it's the best predictor of whether you're going to pay back on time or not. Now, one or two late payments is generally okay. Generally even one or two can affect you a bit, but it's generally okay. More than that can really reduce your score a lot. Now if you end up taking that get out of jail card called bankruptcy, or maybe you have a foreclosure, but it takes a long time to get that off your credit report and get your score back up seven to 10 years. And many dental health care lenders won't even lend to you, no matter how long it's been if you have a bankruptcy in your background. So in reality it's not a get out of jail free card. That's not the way I look at it. Bankruptcy is the absolute desperate last resort. Life is going to end if I don't do this decision. You want to stay away from that, you got to climb out if you're in that desperate of a situation. So hopefully you never have to do that. Alright, now let's go to number two, which is the amount owed. And you might owe 1,000 bucks, you might owe 300,000 bucks, it might be partially a credit card, you might owe $600,000 on your student loans. You've got all these, you've got different debts. So what's the total amount owed? Now there's some interesting things about this one and notice it makes up 30% of what your credit score is. So this one is important. As we get down the list, they become less important, but this one's still important, just like payment history is important. Now, the initial amount of debt, I mean theoretically, think for a sec that you have no debts and suddenly you start to take on debt. Well, the initial amount of debt that you take on, whether that's a credit card or car loan or whatever that is, will actually increase your credit score. Because without any debt, the credit bureaus have no ability to gauge your credit worthiness because you have zero debt, you have no resume at all. So as soon as you take out some, assuming you don't take it out and that very minute, go and maximize your debt and buy a bunch of stuff. Now you've created some space and you have a debt limit, and that might help you. But as soon as you get too much debt, then that can start to harm you as well. Now, here's one of the most important terms when it comes to credit score. It's called your credit utilization ratio. And your credit utilization ratio is a ratio that they calculate on your revolving accounts. Revolving accounts are really, if I just keep it simple, your credit cards, things that you put debt on, you pay it off. You put debt on, you pay it off. Those are revolving accounts. So think of your credit cards. Your credit utilization ratio is how much of the available credit you have that you're actually using. So if you have $100,000 credit availability on, let's say, an American Express card, that's a big amount, but I'm just using an even number here. And let's say you have $8,000 on that credit card. Well, your credit utilization ratio is only 8%, and that's good. Now, a more realistic example might be you've got a $10,000 credit limit and you've got $8,000 on it. Now you have an 80% credit utilization ratio, and that's not good. So you want to keep the balance of your credit card relative to the available limit that you're able to borrow against. Low. And that is called your credit utilization ratio. And the lower you keep that ratio, the better it helps your credit score because you're showing, hey, banks, hey, lenders, hey, credit card companies. I have access to this amount of borrowing, but look at my behavior. I'm not using it all. In fact, I'm just using this much down here. And they look at you and they say that borrower is a disciplined borrower. Their credit utilization ratio is low, and we like that. Now, low debt balances, let's talk about installment loans, which are different than revolving loans. Installment loans are you take out debt to buy, say, a car, and you pay the fixed amount, the same amount pretty much every pay period until the loan is paid off and it's gone. That's called an installment loan. Low debt balances on installment loans relative to the original balance will also help increase your credit score. So it's a similar concept as credit utilization, a little bit different. So if you buy a car and you take out a loan for $20,000, well, if your loan is $19,900, you're not creating much space there, and that's not helping. But when that Debt gets down lower to let's say $5,000 relative to the original $20,000 loan. Well, the banks are looking at that as a positive aspect. So the total debt you have relative to your available debt or what was the original debt on these installment loans will really help your credit. So those two things keep in mind are the majority of your credit score, your payment history, did you pay on time? And number two.

The amounts that you owe relative to the amounts that you could take out or your credit utilization rate. Alright then, third one is the length of history of your credit. Basically the banks and the credit reporting agencies just want to see that you've been good for a long time. You've been managing this for a long time. So the longer the credit history, the better. If you have one credit card for years and that was your only use of credit, don't pay it off until you've established other uses of credit. Now normally I am the type of advisor that says I don't like you to have eight different credit cards at all. It's mismanagement, it's poor financial behavior, it's setting you up to go spend too much. We don't want all of that. But if we. The one credit card we want to close was the credit card you opened up when you were 18 and you've had that for 12 years. And we're going to need to get a practice acquisition loan here in the next year or two. You may not want to close that because that will shorten your credit history. Now that we don't have that and a longer credit history is a good thing. And then over time we can sort of pay off credit cards or maybe close some of the newer cards because they are newer, they don't have much history, you don't need them perhaps. Alright, let's go on to the next one which is your credit mix. Now your credit mix is simply this. You have two main types of debt. You got your revolving accounts, which are credit cards, store cards, your home equity line of credit, and then you have installment accounts, as I mentioned, your mortgage, your auto loan, your student loans and those. I just listed off six there. That sort of ecosystem of loans is what's called your credit mix. And do you have a little bit in each of them? If you. Theoretically, if you had a little bit of loan in each of them and you've been paying all of them current, then the credit agencies are going to like that and your credit score is going to go up because they're saying, hey, this doctor, this person, this Borrower can manage various types of loans, different types of revolving accounts, and also different types of installment accounts. And so therefore we believe they are a healthy borrower that can be relied upon. But just remember, in every category, it's really critical that you always pay off every debt on time, no late payments.

And the last one is new credit. Now, this is only 10%, but there's still a few things I want to mention here. Regardless, whenever you have new inquiries on your credit that will stay for two years, generally on your credit report, and by and large, a bunch of new credit inquiries doesn't help your credit score, that can drive it down, which is sort of a catch 22, because a lot of times you need to take out a loan in order to either move into an apartment or buy a car or whatever that is. And so your credit report has to be checked. And yet we don't want our credit score to go down. However, there's a few mitigating factors here, which I'll mention here in a second. Be careful not to open up too many accounts at once. It's much better if you can open up one account, let's say a credit card, and then continually ask that credit card company to increase your limit on that one card and create a lower utilization rate by increasing your limit while keeping your balance low. Now, there's two. There's one benefit and one disadvantage to opening up a new account or multiple accounts is that new accounts will reduce your credit history, which is the average length of the account history. So if you open up new accounts, suddenly your credit history is shortened because you have a new account with barely any history on it at all. And that's going to shorten the history of your credit. But at the same time, when you open a new account, it's going to give you more of that limit to borrow against. And assuming, like I said, you don't go use that all right away, you now have a lower credit utilization rate because you have more to your limit and your debt or the amount that you've tapped into is hopefully the same. And that can actually help you. Now, if it's a new type of account, your credit mix may actually increase your credit score. For example, if you didn't have, let's say, a car loan and now you go get a car loan for the first time, that could actually help you a little bit. Because now you have a new type of credit, your mix goes up. And as long as you make those payments on time, that could help you. However, new credit inquiries and accounts usually have a small impact. So at the end of the day, if people have to go tap your credit to see if they want to lend you or allow something that's not going to harm you too much, and the credit bureaus usually allow what's called rate shopping, which is if you have, let's say four, four different auto dealerships checking your credit in a two week period, they know that you're out looking for a car right now. And so generally speaking, that's not going to harm your credit. All right, how can you raise your credit score as you're getting ready to buy a practice and you're thinking, I need to be able to get a good loan and I need.

My interest rate on that loan to be lower. Now, interest rate isn't everything. There's other terms of the debt. There's the length of the debt, there's your relationship with the banker and the overall services that the bank is providing you. There's prepayment penalties. There's a lot more at play than just the interest rate. That said, the interest rate does determine in many ways what is the amount you're going to be paying. So it is a relevant factor. So how can we increase your credit score to make sure you're lendable and you can get a good rate? Well, number one, you, you got to know what your credit report looks like. Now there are three credit agencies, as I mentioned, and each one is required to give you a free snapshot, a free report showing your credit history. And if so, if you do one every four months, theoretically that's three per year that you could be taking out. Now I don't think you need to check three times a year, but I'd say once or twice a year you should be doing a pretty extensive review of your credit report to make sure there's no errors. It's been shown that 26% of credit reports have at least one error. So you got to be on top of that. Now I'm a big fan of freezing your credit. Freezing your credit is when you, you freeze it, you sort of lock it so nobody can go and run a credit report on you or take out a loan in your name. Now it's good for fraud protection because people taking a loan from identity theft is pretty rampant these days. And one way to protect yourself is that you freeze your credit. Now you might look at me and say, wes, that's just too much hassle. I don't want to do that. They've actually made Equifax experience Transunion they made it very easy for you to freeze your credit. And then when you need to lift your credit to go run a loan, you can go on their website. It literally takes two or three minutes. You, you lift the credit and you indicate when you want it to unlift or be placed back. And it will happen automatically. You don't even have to go back in and freeze it. So they've done a great job at making this very manageable and efficient to freeze your credit. So I'm a big fan of freezing your credit. I do it personally and I recommend that my clients do it. Okay, so now you're checking your credit report. You're aware of what's going on. Number two is make sure you get a credit card in your name as early as possible. Now, you probably already have one, so I'm not going to spend any more time on that, but just make sure you do. Number three is always pay your bills on time. Goes without saying, but I'm still going to say it because that's how important it is. And then lastly, let's increase your utilization ratio. And I would set up your payments just to be made automatically, like on your credit card or on your car, whatever. Don't be writing checks these days. Don't go online every month and set a calendar reminder. Just set it up to happen automatically. Consider setting the payments to be made twice a month on your credit card so the balance doesn't get too high. Remember, you want that to stay low relative to the overall limit so that your credit utilization ratio is lower. Reduce the amounts of debt that you owe, particularly bad debts. Don't go paying off a good debt like home mortgage or a practice loan or even in this case, your student loans. Before you go, pay off, say a credit card debt or a car debt. And then lastly, request an increase to your credit limit every three to six months. So call amex, call Discover, whoever it is, call them and say, I'd like to request an increase to my limit. And very often they will do that. I've been doing that for many years now. Now, the last thing is really the last thing. Don't close any unused credit cards until you have enough other credit card facilities to make up for the credit card that you close. Now, eventually, when you own a practice and you own your house and cash flow is strong and we don't really have much need for debt, these small nuances aren't going to matter as much. But as you leading up to the moment of buying a practice, they do. So hopefully you may need to come back and listen to this again to make sure you understand all the nuances of how to stage yourself from a credit score standpoint to be able to take out a loan. Alright, I just want to finalize this segment of the Associates on Fire podcast about credit score by showing you what happens to your credit score if you have a slip up. And let's look at some examples.

And you've got two examples. One is you got a credit score of 680 and on the other one you have a credit score of 750. And let's say suddenly you maximize your credit cards, maybe you lose a job, everything's going on credit card, you maximize your credit card balance. What happens to your credit, your credit score? Well, if you're at 680, you're a little bit lower there. It's going to drop 10 to maybe 30 points, but at a 750, it's going to drop 25 to 45 points. So notice that under the credit score, the better borrower, the healthier credit borrower, that borrower is going to experience more of a decline when they make mistakes with their financial behavior. So that means that it takes more work, more vigilance, more discipline for the healthier credit score borrower to maintain that Status. If you're 30 days late on a payment under a 680 credit score, you'll see a drop of 60 to 80 points. Under 750, you'll see a drop of 90 to 110. Debt settlements. That means you got to ask somebody to forgive your debt or discharge your debt because you can't pay it back. You'll see a drop 45 to 60 there for 680. But notice the 750, that's 105 to 125. And then of course you get to the foreclosure and the bankruptcy and it pretty much demolishes your credit score and will make you completely ineligible to take out some key loans you're going to need in your career. So this has been a, hopefully a comprehensive, yet succinct enough description of credit score. Something that you've got to think about, you've got to manage, you can't be passive about and then go to borrow and suddenly find out that your credit score is too low or that there's mistakes on your credit score. You got to own that, you got to manage that. And this module was to give you some context to help you do that.