When it comes to your overall financial health, your credit score is very important – which is why we devote a lot of attention to this benchmark. Your credit score is a solid indicator of your financial habits. It’s an unbiased, data-driven number that reflects your so-called “creditworthiness” – or how likely you are to pay back a debt, based on your credit history.
But, important as it is, did you know that your credit score is only one of the many variables that constitute your financial situation?
Your credit score does not factor in important aspects such as your salary, your credit card interest rates, where you live, any public assistance you might be getting, family support obligations you may have, or your participation in credit counseling. And it doesn’t consider three other important variables to your financial well-being.
1. Your Emergency Fund
Remember that savings account you have squirreled away to cover unforeseen personal catastrophes? (If you’re not nodding your head, it’s time to set one up!) That pool of funds says a lot about your financial strength.
Ideally, your emergency fund contains enough to cover at least three to six months’ worth of expenses. This is your safety net if you lose your job, experience a medical emergency, need major home repairs, or wind up with some other unexpectedly whopping bill. And if you have debt, your emergency fund will help you prevent piling up more to pay for these surprises.
If you’re able to make regular payments into your emergency fund, do it! Consider setting up a monthly direct deposit from your regular checking account (where most of your transactions occur) into this emergency savings account. And then just forget about it – unless you really and truly need it.
2. Your Retirement Fund
In contrast to your short-term emergency savings account, your retirement account (depending on your age, of course) is a long-term strategy. It can be hard to stay focused on a goal that could be many years away, but it’s vital to your future financial stability. Just keep in mind that the sooner you put money into a retirement account, the longer it has to grow. And the longer your nest egg incubates, the more financially viable you will be when you stop working.
If you don’t already have a retirement account, begin by considering how much you can contribute on a regular basis. If you don’t have access to an employer-sponsored retirement account, you can always open an individual retirement account (IRA) through any commercial financial advisor. If you have the opportunity for a workplace retirement savings plan, be sure to sign up. These often offer an employer match to boost the contributions that you make.
How much you should save for retirement is a very personal decision that takes several factors into account, from your current income and lifestyle preferences to the year you would like to stop working. A general rule of thumb is to save 10% to 15% of your annual income (check out this handy retirement calculator for an estimated contribution rate that fits your unique situation).
3. Your Debt-to-Income Ratio
This ratio compares your total monthly debt payments to your gross monthly income. In short, your debt-to-income ratio (DTI) divides the total of all your monthly debt payments by your gross monthly income. Lenders consider this percentage to help them decide whether you can afford to take on more debt – and it can actually be as important as your credit score when you are looking for additional loans.
While your DTI isn’t calculated into your credit score, you still need to track this benchmark because it can impede additional loans. Lenders consider a ratio of 20% or below as financially healthy, but a ratio at 36% or higher shows financial stress and indicates that you are already shouldering more debt than you can effectively manage. Borrowers with high ratios typically have more trouble making their payments.
Start by calculating your ratio. (Use this cool online tool.) If your DTI is high, it’s time to develop a debt payoff strategy to whittle down what you owe. Start by tackling the debt with the highest interest rate, or by knocking out debt with the smallest balance first.
Confused by your credit score? Not sure what it means or how it’s affecting your credit rating? Looking for advice on assessing – and/or improving – your overall financial health? Contact the professionals at American Credit Foundation for guidance.