When you ramp up your savings, you may also help your credit score. The impact is indirect, but extra money in the bank will make it much easier to keep up with bills and minimize debt — and that can improve your credit over the long term.
Credit score basics
Credit scores are three-digit numbers that gauge your creditworthiness and borrowing risk. The two major scoring companies, FICO and VantageScore, calculate scores using the information in your credit reports. Your score doesn’t change based on your salary or savings, but making a habit of saving can help your standing in these two ways:
Payment history: Paying your credit cards and loans on time can help your credit in a major way, since your payment history has a major influence on your score. It’s easier to stay on time with those bills if you have some savings to fall back on.
Amounts owed: If you carry big balances on your credit cards, you may have a high credit utilization ratio, a measure of how much of your credit limit you’re using. Lower is better, because your utilization is another large influence on your credit score. By setting aside more money for incidentals, you can minimize your debts and better your credit.
Get those factors under control, and a high credit score will be much more attainable. Here are some saving solutions that may help.
Problem 1: In hard times, you rack up more credit card debt
When you’re faced with a sudden job loss or a medical emergency and don’t have much in savings, it’s tempting to lean on credit cards, and that can drive up your credit utilization ratio. You dig yourself in deeper by making only minimum payments and letting the interest compound, leaving it easier to fall behind on bills.
Savings solution: Start an emergency fund.
When it comes to establishing an emergency fund, having a plan helps. About 82% of people who make a plan succeed in accumulating sufficient emergency savings, compared with 48% of those with no saving plan, according to a 2015 America Saves Week poll.
To make things easier, consider automatically depositing a portion of each paycheck into a savings account. Once you have six months’ worth of living expenses socked away, you’ll be able to deal with unexpected events without having to break out the plastic.
Problem 2: You can’t imagine retirement without credit
If your only source of retirement income will be Social Security, your access to credit may become more limited, too. That’s because lenders typically extend less credit to people with lower earnings. With fewer credit options, you may have a hard time covering all your living expenses.
Saving solution: Contribute to an IRA or 401(k).
If the thought of living on a fixed income gives you the heebie-jeebies, it may be time to re-evaluate your spending habits. Trim your fixed expenses so that you can contribute a portion of your income each month to an Individual Retirement Account or a 401(k), tax-advantaged retirement savings accounts.
Some companies match a portion of an employee’s 401(k), which could increase your savings further. Once you have more savings to pull from in old age, it’ll be easier for you to keep up with your credit card payments and other obligations — and your credit will stay protected.
Nerd note: Remember to establish a retirement account after you’ve started an emergency fund. If you tap into your retirement account too early, you may have to pay taxes and a 10% fee, and that could eat up a big portion of your savings.
Problem 3: You worry that your kids’ student debt may put a damper on their credit scores
When your youngsters take out student loans for college, it can help them build their credit scores. But too much debt, and they can fall behind on payments and, in some cases, default on loans. If your children are strapped for cash in school, they may also start overusing credit cards, which could lead to a high credit utilization ratio and hurt their credit scores.
Saving solution: Set aside money in a 529 plan.
As college tuitions continue to rise, it’s more important than ever to save for higher education — the earlier, the better. When your children are young, consider setting up a 529 plan, or a tax-advantaged account for their college expenses.
With monthly contributions, your kids won’t have to borrow as much for college. With less debt, they’ll have a better shot at building excellent credit early on — and that could save both of you a fortune in the long run.
This article was updated Sept. 30, 2016.