A credit score indicates how consumers handle debt. Understanding how credit scoring works is useful for making decisions about student educational loans and other credit that can potentially impact your education and career goals. The Fair Isaac Corporation developed its credit scoring (also known as FICO scoring) system based on weighting five aspects of a consumer’s credit history to achieve a score between 300 and 850.
How is my FICO Score Computed?
35% = Payment history: This category includes payment information on retail accounts, auto loans, mortgages, revolving credit, installment debt, and student loans. Delinquencies, repossessions, bankruptcies, wage garnishments, and liens are included. Public filings such as legal judgments can also show up and negatively impact your score, even if paid. Negative items on your payment history can lower your credit score for 7 to 10 years!
30% = Amounts owed: This category includes how much you owe and the percentage of available credit used for revolving accounts. A good way to improve your credit score is to avoid running up large balances or using more than 30% of your available credit.
15% = Length of credit history. The average consumer has approximately 14 years of credit history, but this isn’t necessarily true for students or those who’ve recently started careers. Repaying student loans on time provides a solid foundation for establishing a good credit score.
10% = New credit: Credit scores reflect new credit activity. Opening too many accounts too quickly can drop your credit score. It’s important to understand the difference between opening new credit accounts and credit inquiries; for example, if a potential lender or employer makes an inquiry it impacts your credit score less than applying for several credit cards in a short period of time.
10% = Types of Credit Used: The types of credit you have influences your credit score. Financial expert Suze Orman categorizes student loans as “good debt,” like mortgages or auto loans, but advises against opening and carrying balances on multiple credit cards. College students may be tempted to use credit cards as a financial “bridge” until payday, but this can result in accumulating excessive debt.
Student Loans: The Gateway to Your Future
As the cost of undergraduate, graduate, and professional education continues to increase, students are taking advantage of low cost federal student loans. According to the Project on Student Debt and the College Board’s Center for Economic and Policy Research, approximately two-thirds of recent graduates carry student loan debt and over the past decade, student debt levels have more than doubled.
These figures suggest that many students start their careers with significant debt before they’ve had a chance to build a solid credit score. As public academic institutions continue to face budget cutbacks and tuition increases, students may have to rely more heavily on student loans and credit cards to get by; this can have negative consequences for students’ credit scores and may even delay or divert career plans.
Career Transitions and Your Credit Score
If you’re considering a mid-life career change, a good credit score can help you obtain financing for the transition to a new career. It’s important to weigh short and long term financial goals when considering taking on student loan debt. Consulting a financial advisor can help establish a plan to fund your career transition while protecting your credit score.
Consolidate Student Loans
Traditionally, the interest rates for federal student loans are low–between 5% and 7.22%. Students can include multiple student educational loans that have different or variable interest rates into one consolidation loan with a fixed interest rate and single payment. The interest rate for consolidation loans is based on a weighted average of the interest rates of the different loans included in the consolidation.
Federal student loan interest rates are adjusted on July 1 and, on July 1, 2008, are expected to decrease significantly. Consolidating student loans fixes your interest rate and can help you avoid late or missed payments caused by managing multiple student loans; you may want to wait until after this year’s interest rate adjustment, however, to make an informed decision whether or not to consolidate.
When Should I Consolidate My Student Loans?
Students often consolidate loans during the grace period immediately following graduation, but it’s also possible to consolidate while you’re still in school. This may get you a lower rate on your consolidation loan but be aware that some loan cancellation or other specific loan benefits could be lost if you consolidate before you graduate or during your grace period.
Understanding Student Loan Debt
Unfortunately, it can be tempting to borrow more than you need for educational expenses. And it’s easy to forget that unlike grants and scholarships, student loans must be repaid, which can cause financial problems and damage your credit before you even have a chance to establish a good credit history. Late payments and collection activity on student loans leads to low credit scores–especially if, like many students, you have a short or limited credit history. A low credit score can limit the availability of some student loans and other types of credit including mortgage loans. And borrowing more than you need may affect your plans long after you’ve graduated–a 2006 Money Magazine article describes how some college grads are delaying buying a home or starting a family while they repay large student loan balances.
The Connection between Your Credit Score and Career
A spotty credit history can not only make it hard for you to get approved for loans, it could even ruin your career plans. Low credit scores can limit access to business loans and prospective employers often conduct background checks that include verifying your credit score. When you interview for jobs you may be asked to sign an authorization that allows prospective employers to check your background. Employers in the financial and retail industries and professions such as accounting and law typically use background checks as part of the hiring process, and a low credit score is a valid reason to deny employment.
Careful use of student loans can provide for your education and help avoid unnecessary debt. Managing student loan debt through prompt repayment and possibly consolidation can help establish a good credit score. Your education and credit score can open doors to your new career, and later, help you get financing for expanding a business, starting a company, or investing for your future.
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