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Plan Well, Retire Well

Saving and investing your money
accountant-1238598 1920

I’m thinking of a Number between 300 to 850


I remember when I first started to learn about how to build and manage my credit in college. Many financial numbers were thrown around and were often confusing to a novice like me. People who do not work in finance or who have little motivation to pay attention to the importance of different numbers, or why lenders rely on them, may overlook them.

Some numbers have significant effects on our financial lives. If you are planning to take out any loan (e.g., car, mortgage, student, or smaller bank loans), it is a good idea to understand which numbers matter to creditors.

Credit Score. Your credit score is based on a mathematical formula that is used to measure your likelihood of repaying a loan. It is a 3-digit number that ranges from 300-850 (higher numbers are more favorable to lenders). The main components of a credit score are payment history, amount of debt owed, length of credit, amount and type of credit, and new credit. One question I get a lot about credit score is "why do I have multiple scores?" The short answer - different credit reporting agencies produce your scores, and those numbers reflect what the agency is reporting. You may also hear a lot about FICO (Fair Isaac Corporation) score. FICO is a company that produces the most widely used credit score.

* It is important to note that credit score doesn't consider your income

Debt-to-Income (DTI) Ratio. DTI measures the percentage of your debt compared to your income. To calculate your DTI, divide your total recurring monthly debt by your gross monthly income. Here is an example from the Consumer Financial Protection Bureau (CFPB):

If your monthly bills add up to $2,000 and your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent. ($2,000 is 33% of $6,000).

When I was applying for my mortgage, I had conversations with my lender about my DTI. Creditors usually encourage a DTI below 43% to qualify for a mortgage that you can afford. DTI indicates to your lender that you are not taking on more debt than you can handle. It may vary depending on the creditor and other mitigating factors, so check with your lender to learn about their ideal DTI.

Credit Utilization Ratio. To calculate this ratio, divide the total balance of all your credit cards by the limits of all cards and then multiply by 100. For example, Sally has two credit cards. Credit Card Blue as a limit of $5,000 (total loan to you) and a balance of $2,000 (the amount you spend). While Credit Card Orange has a limit of $2,000 and the current balance of $500:

Total balance for both cards: $2,000 + $500 = $2,500

Total limit for both cards: $5,000 + $2,000 = $7,000

Utilization percentage: $2,500/$7,000 = .3571 or 35.71%

Financial experts encourage that we keep credit utilization as low as possible – preferably below 30%. Credit utilization plays an important role in determining credit scores and creditors rely on credit scores to decide whether to lend to us.

Emergency Savings. While this number is flexible and a little different from the ones mentioned above, it is equally important (in my opinion). Also known as a rainy day fund or contingency savings, an emergency fund acts as insurance for the unexpected (Collins & Gjertson, 2013). Financial experts offer varying recommendations about the exact amount you should have in an emergency savings account. Some suggest having three-six months' worth of income and others believe that might be too unrealistic for many people and encourage having at least $500 in savings.

In summary, if your credit score is low, your credit utilization percentage is high, or you don't have an emergency fund, there are techniques that you can use to stay in a great place financially:

  • Pay your bills on time
  • Pay more than the minimum monthly payment
  • Watch your credit utilization and make sure you are not close to your credit limit
  • Start small with your emergency savings and automate a monthly amount to a savings account

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