by Sherry Hao, Controller at U.S. Money Reserve
Credit can be a tricky thing to navigate, and there are times when it really pays (and saves you money) to have a great credit score. Having a stellar credit score can help get a better interest rate on everything from car loans to credit cards and mortgages. Plus, it can help you get a better job, so it’s really important that you understand what makes up your credit score and what you can do to improve it.
According to recent numbers from the New York Federal Reserve, America’s personal debt jumped to more than $14 trillion in 2019. That’s an increase of more than $601 billion from 2018. Of that, more than $55 billion is tied up in auto and credit card debt. That’s a lot of scratch, and managing it requires a good, solid understanding of some basics.
While you may not pay a ton of attention to that magic little number (your credit score) regularly, doing a credit score check-in makes a ton of sense as things can change and impact your credit score without your knowledge. Here are five easy ways to improve your credit score.
Understand Your Credit Score
First, it’s essential to understand the basics that make up your credit score. A credit score is a number that the major credit bureaus assign you based on your credit utilization or how much credit you’re currently using, whether you pay your bills on time and in full, and the length of time you have had your credit open, among other things. It is different from your credit report.
You can pull your credit report from the three major credit bureaus for free once every year by visiting annualcreditreport.com. While this won’t tell you what your credit score is (you’ll need to purchase that separately), it can give you a good insight into what kinds of marks are on your credit report and what steps you need to take to improve your score.
The two major credit scoring companies in the U.S. are FICO and Vantage Score. They use the information in your credit report to score how creditworthy you are based on a variety of factors that they largely keep under wraps. While the way they come to their credit score is a highly guarded secret, there are a few basic things we know that help comprise your credit score.
Both companies use this factor to determine how likely you are to pay back any debt you take on. This factor significantly impacts your credit score. Your credit history shows whether you have consistently paid your bills on time, for the length of time you have had your credit open. FICO says that credit history makes up 35% of their credit score, and Vantage Score says that it weights payment history as “moderately influential” in the creation of their credit scores.
Total Credit Utilization, Amount of Debt, and Available Credit
Both FICO and Vantage Score take your credit usage or utilization, amount of debt, and available credit into consideration when creating their credit scores. Amounts owed make up 30% of the FICO score. Vantage Score says that the combination of amounts owed, total credit usage, and available credit are “extremely influential” in creating your credit score.
The Other Factors
Outside of these two main categories, the credit scoring agencies are largely mum about what goes into your credit score, but there are a few other things to know that can impact your credit score both positively and negatively. They include:
- The length of time that you have had open credit: The longer that you have had open credit, the better.
- Your credit “mix”: The types of credit you carry matter. There are two types of credit that credit scoring companies look at: revolving credit, which is open-ended with payments due each month, like credit card debt, and close-ended or installment credit, like car loans or mortgage debt.
- Credit inquiries: Credit scoring companies like to see a good balance of new and old accounts. Hard credit pulls ding your credit, while soft credit inquiries do not. According to Mint.com, credit inquiries (the hard ones) remain on your report for up to two years.
- Total balances and debts: The credit scoring companies also take your total debts and balances into consideration. This can include things like your mortgage and auto loan debts as well as your credit card debt.
How Can You Improve Your Credit Score?
Once you have a grasp of what goes into your credit score, you can work toward improving it. Think of improving your credit score like preparing to run a marathon: Each small step builds you up to complete the full 26-mile haul. While you can improve your credit score in a few weeks, it typically takes months or years to see significant changes in your credit score.
Here are five ways you can improve your credit score.
Pay your debt on time, every time
As I mentioned above, payment history matters tremendously when it comes to managing and improving your credit score. Both FICO and Vantage Score use your debt repayment information as a significant portion of your score.
Your repayment history shows other lenders how likely you are to pay back your debts on time. Lenders assume that if you paid your past debts on time, then you will pay future ones on time, too, and they are more likely to lend you money.
One thing to remember about your debt repayment is that while it wouldn’t be ideal, you could pay just the minimum balances on your outstanding debt and still improve your score. It will take a very long time to repay all your debt if you only make minimum payments, but it is one strategy that can help improve your credit score in short order.
Do your best to avoid late payments, defaults, repossessions, collections, and foreclosures. These all ding your credit pretty severely and can take a long time to recover from.
Stay on Top of Your Credit Utilization
Credit utilization is a fancy way of saying how much of your available credit you are using at any given time, and it plays a significant role in your credit score for both FICO and Vantage Score. The best rule of thumb, according to Bankrate, is to try to keep your credit utilization between 7 and 10% of your total available credit. In general, credit utilization focuses solely on revolving debt or credit card debt.
As an example, imagine that you have a total credit limit of $10,000 across all your credit cards. That means that you should try to keep your balance across all the cards to around $700 per month. Paying off your debt each month is very important, too, but as Bankrate recommends, if you start to have trouble with mounting debt and high-interest rates, it might be beneficial to look into transferring your higher balances to a new card with a lower interest rate.
Don’t Go Crazy with New Credit and Keep Old Credit Open
Another trick to boosting your score is to keep your new credit inquiries to a minimum and maintain older credit accounts.
New credit inquiries that require a “hard” credit pull — one where a lender gets your consent to look at your credit to determine how creditworthy you are — will ding your credit score. These kinds of pulls are generally done when you apply for a credit card, apply for a loan (car or home), or when you apply for a student loan or personal loan. You have to provide your information and consent. No lender can do a hard pull on your credit without your explicit consent.
Soft credit pulls will not require your consent and happen all the time. Think about those credit card offers you get in the mail — those are based on soft pulls. You might also have a soft pull done when you get preapproved for a loan of any type.
The lesson here is to do your best to avoid the hard credit pulls unless you need them. That will help keep your credit score in good shape. The more hard pulls on your credit in a short period of time, the more your score will drop.
When it comes to credit accounts that are older, relatively inactive, or paid off, it pays to keep them open. These open accounts help establish your credit history (which we address above) and show that you have both taken on debt and paid it off. That is an important marker for the credit scoring companies.
Keep your Debt-to-Income Ratio Low
It isn’t rocket science, but it bears repeating: Don’t overspend. Keeping your debt-to-income ratio low is the best way to keep your spending under control. Your debt-to-income ratio is the amount of debt divided by your gross monthly income. If you apply for new credit, you’ll be asked for your income, and that can impact how much credit you will be permitted to take out, which will, in turn, impact your credit score.
Pay off your debts in full if you can, and your credit score will continue to improve.
It takes time to improve your credit score, and while you can see some improvement over a period of weeks, building up a good credit score can take years. Making payments on time, paying off debt, and waiting for hard credit pulls to fall off your report can all help improve your credit score. Know that each small step you take will eventually have a positive impact on your credit, but it is going to take some time for those benefits to show up.
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