How To Improve Your Credit
It’s disappointing to hear: your application for a loan, whether it’s a credit card, mortgage or auto loan has been denied due to poor credit. The first thing you should know is you’re not alone. Each year, millions of Americans will find themselves in the same situation, and it’s not just access to financing. According to the Society for Human Resource Management, around 47% of organizations use credit as a part of their hiring decision process.
Credit is an important metric not just for your financial health, but for opportunity overall, but what does it mean to have “good credit”? How do you get it? And if you’re looking to improve your credit, what steps can you take to get there?
Let’s start from the beginning.
What’s a credit score?
When we talk about good or bad “credit” what someone is really trying to assess is the likelihood a loan will be repaid. Often, this gets expressed as a numerical score. In the US, most lenders use a system developed by the Fair Isaac Corporation you may have heard of called the FICO score. There are other types of credit scores too, like the Vantage Score, which operate similarly. Think of these scores as your credit letter grade, but instead of A through F you’re graded on a scale of 850 to 300.
In the case of FICO, here’s how those scores break down:
850 - 800: Exceptional
799 - 740: Very good
670 - 739: Good
580 - 669: Fair
Under 580: Poor
In addition to getting approved for credit, consumers with higher credit scores will often qualify for better loan terms, like lower interest rates, that can be big money savers.
How is it calculated?
Your credit score is developed from data available in your credit report. Credit reporting agencies collect and maintain information about you to develop these reports. They contain information on where you live and work, if you’ve filed for bankruptcy, as well as current credit factors like your debts or any payments you’ve made. Each credit reporting agency maintains its own information about you, and they may not be the same. Lenders use both your credit score and your credit report to make credit decisions.
Your credit score is calculated by weighing certain pieces of data in your credit report. Some factors carry more weight than others. In the case of FICO, it looks like this: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%).
Let’s take a brief look at each input.
Payment history - The single most important factor in determining your credit score, lenders want to know if you’ve made past credit payments on time.
Amounts owed - What is cared about here is the credit utilization rate, or the sum of all your balances divided by your credit limits. If you’re using a larger amount of the credit available to you, it can reflect negatively on your score.
Length of history - Having an established history of paying your bills will help your credit score. Lenders will also look at your oldest and newest accounts, and how long it’s been since you used certain accounts.
Credit mix - Lenders will consider your ability to manage different credit accounts, such as revolving credit, like a credit card, and installment credit, like a student loan. Managing various types of accounts can positively impact your score.
New credit - If you open a lot of accounts all at once, research has shown it can negatively impact your score, especially if you have a short credit history.
So how do I improve my score?
You know what a credit score is, and why it’s important, so how do you improve it? Here are few ways you can make an impact on your score, some of them right away.
- Clean up your credit report - A study by the FTC found that 1 in 5 people have an error on at least one credit report. Get your free credit report and make sure yours are error-free. Finding and disputing an error on your report could net you an immediate credit upgrade.
- Pay your loans on time - Payment history matters more than anything. Many lenders offer the opportunity to set up automatic payments, which can be helpful. You can also set your own personal reminders to pay your bills on time as well if you’re struggling to do so.
- Be disciplined - Building credit means you need to be using credit, but it can be easy to get carried away. Only use credit to purchase things you can afford to pay off that month. It will help to keep balances low and your payments on track.
- Don’t get maxed out - It can feel good to transfer balances and cancel out old credit cards, but that won’t always help your score. If you use a higher percentage of your total available credit, that will cost you. Experts recommend keeping your credit utilization under 30%. Also you do not need to keep a balance on credit cards to get good credit. Paying them off at the end of the billing cycle is always a good call.
- Ask for higher credit limits - If you’ve had an open account for a while and your financial circumstances have improved, such as a salary increase, you may be able to increase your credit limits. This will lower your credit utilization and could give your score a boost.
- Deal with past due accounts - Make sure you’re current on all your accounts and deal with any accounts in collections. These can be serious marks on your credit and putting them in the past can offer a boost, as well as piece of mind.
- Keep track of your progress - Sign up for credit monitoring services (many of which are free!) to keep track of your credit progress and spot any potential issues.