Optimizing Your Credit Score in 7 Steps
Are you thinking about buying a car, renting an apartment, or purchasing a home? What about simply qualifying for a new cell phone plan or a credit card? Your credit score is an important factor in determining how successful you’ll be in achieving these goals.
Credit scores can be as low as 300 or as high as 850. What constitutes a good credit score will vary, depending on the type of loan you’re getting and your lender’s specific requirements. A solid score generally ranges between 680 and 720. Getting the best interest rates and loan offers typically require a credit score of 750 or better. Yours not up to snuff? Don’t panic! Improve your credit score with the following seven steps:
- Understand how your credit score works
- Obtain a free credit score and report
- Pay your bills on time
- Keep your debt-to-limit ratio low
- Pay down credit card balances
- Maintain old accounts
- Use caution when opening new accounts
1. Understand how your credit score works
A credit score is a three-digit number that lets lenders know how much debt you already have and whether or not you pay your bills on time. Your credit score influences how much money you can borrow from a lender – and what your interest rate will be. The higher your credit score is, the more likely you are to get a loan. For example, according to Fair Isaac Corporation, a person with good credit can pay about $757 a month (at 5.175% APR) for a $25,000 auto loan over 36 months. A person with poor credit winds up paying closer to $912 a month (at 18.68% APR). Over the life of the loan, that’s an extra $5,580 in just three years!
You should have a general idea of what your credit score is before you take steps to boost it. It’s best to gather this information at least six months before you plan to make a major purchase. This will give you time to develop a plan for making any necessary improvements, especially if your score is poor. It’ll also allow you to clear up any mistakes lenders have made in reporting on your existing accounts.
2. Obtain a free credit score and report
A number of companies claim to offer free credit scores. These offers may sound tantalizing, but beware! Many are actually gimmicks used to entice you into purchasing some other product, such as credit monitoring services. A couple of legitimate sources do exist, including Credit Karma’s free credit score calculator or the credit score estimator available from Fair Isaac Corporation at myFICO.
You should review your credit report in addition to your score. Your credit report shows lenders how much money you owe, the amount of credit you currently draw on, and whether you make payments on time. A typical report contains information about debts like credit cards, car payments, mortgages, and student loans. It also lets a lender know if you’ve filed for bankruptcy, been arrested, or been sued by creditors. You can get a free copy of your report once a year from each of the major credit bureaus – Experian, TransUnion, and Equifax. Secure a copy from at least two of these sources so you can check the reports against each other for accuracy. Plan to review your report and score about once a year. Use the report to keep tabs on your credit health and to verify that you haven’t been the victim of identity theft.
3. Pay your bills on time
This simple step is one of the best ways to increase your credit score. After all, payment history accounts for about 35 percent of your total credit score. The formula is simple – your credit rating gets better over time if you pay your bills when they’re due. Unfortunately, this doesn’t happen overnight.
Establish a bill payment plan and timeline. This is particularly important if you have a history of making late payments. Start by compiling a list of your bills, noting when each one is due and how much you typically pay per bill. Next, develop a schedule for paying each bill. You can chart this out in your daily planner or calendar to help you remember when each bill is due, or consider setting up automatic payments so you’ll never forget. Auto-pay is typically available at no cost through the lending companies servicing your accounts or through your bank. It’s best to schedule payments directly after you’re paid to ensure that you’ll have enough money to cover what you owe.
4. Keep your debt-to-limit ratio low
Your debt-to-limit ratio tells vendors how much of your available credit you’re using up. It’s calculated by dividing what you’ve spent by your total credit limit. For instance, your debt-to-limit ratio is 90 percent if you have a $2,000 credit card limit and have charged $1,800 to the card. If you have a high debt-to-limit ratio, a vendor will likely identify you as a high risk borrower. Your ideal debt-to-ratio limit will be ten percent or less, although a limit in the neighborhood of 30 percent is generally considered healthy.
Your debt-to-limit ratio could appear artificially high if your credit limit is lower than what you should actually be qualifying for. Many lenders will increase your credit limit if you ask and if you have a good payment history.
5. Pay down credit card balances
About 30 percent of your credit score is impacted by your outstanding obligations, and credit cards often account for a significant portion of total debt. Establishing a good credit history requires keeping your credit card balances low. If you’ve racked up mountains of debt, develop a plan for paying it off. Write down what you owe and how much interest is being charged on each debt. Plan to focus on paying down cards with higher interest rates first. Several online tools are available to help you figure out how long your repayment plan will take. The Federal Reserve, Smartmoney.com, and Bankrate.com all offer free calculators that tell you how many months it will take to pay off your credit card based on the amount you owe, your interest rate, and other factors.
A credit card balance of zero is obviously ideal, but you can start small. Your score will improve if you can bring your outstanding balances down to 35 percent or less of your allotted credit amount. Strive for a credit card balance that’s ten percent or less of your credit limit if you’re going to apply for a major loan, such as a new car or mortgage, in the near future.
How many credit cards should you ultimately have? There isn’t a hard and fast rule, as you can still build a good credit score even if you don’t have any credit cards at all. Generally, you should have as many cards as you can handle responsibly. If you haven’t had a card before, start by opening up two cards. That way you can use one as a back-up in the event your primary card is stolen, lost, or not accepted at a particular business. Only use one of the cards to make online purchases. This will help reduce the possibility of identity theft and make it easier for your credit card vendor to spot any fraudulent activity. Above all, make a habit of paying off the balances on your cards each month.
6. Maintain old accounts
A long credit history can influence up to 15 percent of your credit score. While this might seem obvious, most people don’t know that old accounts can help bump up their scores. For example, a credit card that hasn’t been used for six months may be reported as inactive. Inactive accounts usually aren’t factored into your credit score, and you won’t get the benefit of your good history. Use these old accounts once every six months to make a small purchase. This will keep the account status active and help improve your score.
7. Use caution when opening new accounts
Ever been offered an extra 20 percent off on a purchase if you open a new credit account with that retailer? This may seem like a killer deal, but it can knock as much as ten percent off your credit score. Having multiple credit accounts that you don’t use can actually lower your credit score over time. Don’t assume that closing unused accounts can help your rating. You’ve already done the damage simply by opening the account so closing it won’t do any good. In fact, it could even hurt your score in some cases. The better practice is to carefully consider whether to open a new account in advance. If it’s something you’ll use regularly, it can help build your credit.
When you apply for a loan or credit card, a lender normally pulls your credit history. This is known as a hard hit. Your credit score can drop if you have a history of too many hard hits. You can minimize this risk by applying only for loans you really need and doing your homework before applying. Instead of applying for a loan from a dozen vendors, for example, research the vendors in advance. Find the two or three that look like the best fit for your needs and then fill out an application. That will help minimize the total number of hard hits on your score.
You should also consider what your current credit mix consists of before opening a new account. The types of accounts you use can impact up to ten percent of your total credit score, and a good mix will help your score. Having a credit card, installment car payment, student loans, and mortgage, for example, shows a lender that you can act responsibly with a variety of different loans. On the other hand, having 20 credit cards doesn’t show a lender that you can responsibly manage other kinds of credit.
Repairing your credit history isn’t always easy. These simple credit tips can help you build your credit history, improve your score, and secure better loan terms in the future.
By: Charity Delich
4-19-2010
Charity Delich is a professional writer and a practicing attorney. She lives in New York City, where she's working on a master's degree in publishing at New York University.
