Do you remember studying the food chain long ago? Plants capture energy from the sun to produce their own food, and are therefore called “producers.” The animals that eat those plants, or other animals, are labeled “consumers.” When we think of humans as consumers, we may immediately think about our consumption of food and drink. However, we also use the term consumers when describing our financial saving and spending habits.
Part of what helps us to be wise financial consumers is to understand financial terms that we may be familiar with, but not completely understand. Here is a review of a few key terms that might be helpful for you or someone you know.
Credit Report – It can be easy to confuse a credit report with a credit score. A credit report contains information that each credit bureau has about a consumer. Information includes details such as history of accounts, number of inquiries, and number of collections. The three credit reporting agencies are Equifax, Experian, and Transunion. All consumers have the right to check their credit report from each agency annually at annualcreditreport.com. Because of the ongoing pandemic, everyone can check these weekly for free.
Credit Score – A credit score, on the other hand, is a numerical interpretation of a consumer’s creditworthiness based on information in his or her credit report. Credit scores are often referred to simply as FICO scores. FICO stands for Fair Isaac Corporation and is the most used scoring model for lending and credit decisions in the U.S. FICO scores range from 300 to 850 and higher is better.
Factors that make up the credit score include account history (including late payments), amounts owed (ratio of what you owe compared to your credit limit), length of credit history, new credit, and types of credit used (including revolving credit such as credit cards and installment credit like a car loan, student loan, or mortgage).
When considering the purchase of a home, a credit score of 640 or higher is usually required. There may be options for a lower score, but financing will come with some significantly higher interest rates. A higher credit score will qualify for better mortgage terms.
Debt to Income (DTI) Ratio – This is a ratio that calculates a borrower’s total monthly debt, including housing and other debt obligations, as a percentage of gross monthly income. Monthly debt includes auto and student loan payments as well as housing expenses (principal, interest, taxes, and insurance). This ratio is frequently used by lenders to qualify borrowers for a mortgage. A DTI of 36 percent or lower is considered ideal for a conventional loan. Other types of loans can have higher DTI.
Today I’ll leave you with this quote from Ayn Rand , “Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver.”
