6 Ways to Improve Your Credit Score
In today’s global economy, managing and improving your credit score is crucial to your financial future. Obtaining employment, purchasing a new vehicle, or buying a home all revolve around your credit report and credit score. Having a good credit rating will lower your interest rate on everything from student loans to your mortgage. Employers even run credit checks as a method to determine the trustworthiness of potential employees as part of the application process.
It is important to differentiate between a credit report and a credit score. Banks and lending agencies use a credit report to look at the 6 C’s of credit worthiness: character, capacity, collateral, conditions, credit, and capital; these will be discussed in detail in another article. The key learning point is that your FICO credit score is a numerical representation of the 6 C’s that ranges from 300 to 850. For the purposes of this article, we will focus on the FICO credit score, which is determined by the below factors:
FICO Credit Score Composition
30% - Credit card debt
31% - History of repaying loans
15% - Length of credit history
14% - Type and number of credit cards
10% - Credit applications & Inquiries
Improving any of the above factors will naturally increase your score. While some will allow this to occur with the natural progression of time, others prefer to take action to speed up the process.
1. Lower your revolving debt to credit ratio – Revolving credit, simply put, is the credit available through your credit cards. Your revolving debt to credit ratio = (sum of all credit card debt) / (sum of all credit card limits). Ex: you have two credit cards each with a limit of $1,000.00 and you are carrying a balance of $500.00 on each of them. Your revolving debt to credit ratio would be 1,000/2,000 or 1/2. You can lower your debt to credit ratio by either paying down some debt, or by increasing your credit limit. I recently requested a $20,000.00 credit increase on one of my credit cards, which raised my credit score by 40 points.
2. Make all payments on time – Consumer loans, or installment loans, are quite unforgiving when it comes to the terms for defaulting on the loan. Missing a single payment or submitting it late is looked poorly upon by the credit agencies. Additionally, defaulting on a loan can send your interest rate soaring, and may extend the time period it takes to pay off your loan due to higher interest payments. Always make payments early when possible to save on daily accrued interest.
3. Do not close credit accounts too early – Duration accounts for 15% of your credit score. Even if you pay off a line of credit or credit card, it is better to leave the account open rather than close it. Lenders want to see an established credit history which translates into credit experience.
4. Ensure you have the right type and number of credit cards - Credit cards fall into two classes: 1) Major cards and 2) Retail cards. Major cards are the traditional Visa or Master cards that can be used anywhere credit cards are accepted. Retail cards are those which are store sponsored and can be used at a specific store such as American Eagle or Dillard’s. Owning two major cards and two retail cards with minimal balances is favorable to your credit score because it shows that you are responsible enough to manage multiple accounts. Think diversification.
5. Limit the number of “hard” credit inquiries made on your account – There are two types of credit inquiries; 1) hard and 2) soft. Hard credit inquiries are those which are made when you apply for credit and give your permission for a bank or lender to evaluate you for credit. Soft inquiries are those which are made by yourself when checking your own credit score or when a background check is conducted on you. Hard credit inquiries will stick to your credit report for two years and having too many of them on your report will drop your credit score.
6. Limit the number of installment loans open on your account – Installment loans, also known as consumer loans, carry fixed monthly payments and are viewed negatively because they will limit your ability to meet other monthly financial obligations.