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How to Improve Your Credit Score

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Having a strong credit score is one of the most important things you can do to help control your finances. Your credit score is used every time you apply for a loan, to help determine interest and insurance rates, for background checks when you apply for a job or for renting a house, and even when you want to enter a cell phone contract.

Yesterday I wrote about how FICO Credit Scores are determined. The calculation is based upon your credit payment history, amounts owed, length of credit history, new credit, and types of credit. Now I will share some ways to improve your credit score.

This chart breaks down the components of your FICO score by importance.

Improve your credit score

Credit Score Breakdown

How to improve your credit score

The most important thing anyone can do is pay their bills in full on time, every time. In addition to paying your bills on time, these tips can help you improve your FICO credit score:

Payment History

Your payment history comprises 35% of your credit score, so it is important to make your payments in full and on time. Delinquencies will have a negative impact on your score, and any loans that go to collections can stay on your credit report up to 7 years or longer – even if they have been paid in full. There is good news though. The longer you pay your bills on time, the more positive the effect on your credit score.

To improve your credit score, concentrate on making your payments on time, every time. If you feel like you might have a problem meeting your payments on time, call your lender and try to work out an arrangement where they can get their money and it won’t affect your credit score. Some lenders are willing to work with borrowers when given the chance.

Amounts Owed

The amount of money you owe makes up 30% of your credit score. Lenders look at your total available line of credit and ask this question: “worst case scenario, how much money can they borrow, and would they be able to pay it all back?”

Some of the important factors to consider include the total amount of money owed, available credit, the amounts owed for each type of account (secured debt and unsecured debt), number of accounts with balances, proportion of available credit used, and proportion of installment loan remaining vs. starting balance.

To improve your credit score, the most important thing you can do is pay down your debt to reduce the amount you owe. Next, try to keep your revolving credit balance low (such as credit card debt). Another tip is to close or reduce available lines of unused credit. For instance, if you have an unused HELOC or other available credit line that you aren’t using, you may improve your score by reducing the amount you can borrow. However, be careful opening or closing too many accounts to try and raise your score – the opposite effect could happen if you make several major changes in a short period of time.

Length of Credit History

You credit history affects your credit scoreLenders want to lend money to people who have consistently shown the ability to repay their loans. The longer you have proven your ability to repay loans, the more favorable you look in the eyes of the lender. The average age of your credit accounts makes up 15% of your credit score. Be careful opening too many credit accounts at once because that can lower your average age of credit. This is even more important if you have only recently established your credit history.

To improve your credit score, do not close old credit accounts. If you do not need the line of credit any longer, ask the company to reduce the available line of credit to the minimum and cut up the card and don’t use it anymore. This reduces the temptation to continue using the card, but you retain the benefits of keeping the old line of credit in your credit history. If the line of credit is newer, it may not hurt to close the account.

New Credit

New credit makes up 10% of your credit score. Too many recent credit inquiries can also have a negative affect on your credit score.

To improve your credit score, try to do all your interest rate shopping in a short period of time. For example, if you are shopping for a mortgage or car loan, try to do it all in the span of a couple weeks instead of dragging it out over months. Checking your own credit score will not have a negative impact on your scores if you get a copy of your credit score from an authorized agency such as the three major credit bureaus – Equifax, Experian, and TransUnion, or from MyFICO.com where you can get all three at reports once. MyFICO is also the company that created the FICO credit score.

It is important to note that it is OK to open new lines of credit if you need to reestablish your credit history, just be sure to pay off your new loans on time. Try to limit the number of new credit accounts you open in a short time period.

Types of Credit

There are several types of credit, and lenders like to see that you have the ability to handle them equally well. The types of credit you have makes up 10% of your score.

To improve your credit score, try to maintain a mix of installment loans (such as a car payment or mortgage) and revolving credit (such as a credit card). This shows lenders you are capable of making regular fixed payments, as well as maintain the ability to regularly make charges and pay them off. Having a mixture of secured and unsecured loans can also affect your credit score.

There is no quick fix to improve your credit score

But there are many things you can do to improve your score over time. The most important thing is to make regular payments and to reduce your amount of debt. You can also consider consolidating accounts, reducing the amount of available credit you have, leaving your oldest credit lines open, and having different types of credit (installment loans, revolving credit, secured loans, unsecured loans, etc.).

Keep in mind that closing your credit accounts does not remove them from your credit report or your credit score. Closing the accounts is fine, but you have to consistently pay your remaining loans on time to improve your credit score.

Finally, only open new credit accounts when needed. This will limit the amount of available credit you have, reduce the number of new accounts in your name, and help keep the average age of credit up – all of which are important elements to your credit score.

You can get a copy of your credit report free, through the MyFICO website, or from the three major credit bureaus – Equifax, Experian, and TransUnion.


Published or updated October 29, 2012.
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{ 27 comments… read them below or add one }

1 Dividend Growth Investor

Great article. Thanks for the tips on improving our score. I recently thought about closing my first credit card, since I no longer used it, but the guy there reminded me that my score might drop b/c of that..

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2 Ryan

DGI, I closed my oldest card just over a year ago, before I knew how credit scores are determined. I had that credit card for about 10 years when I closed it, and now I think my oldest card is around 3 years old. I closed it because I hadn’t used it for several years, but I wish I had left it open… Oh well! ;)

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3 MelStar

Excellent breakdown. Yeah also closing out those accounts can have the effect of reducing your available credit. Let’s say you only have one credit account, (not looking at the other factors involved), and the limit is $5,000 with a zero balance. Now you go out and spend $2,500, you have just used up 50% of your available credit and creditors will start to frown on this when you try to borrow.

When you start using 35% of your avialable that’s when they cast a suspicious eye at you.

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4 Ryan

Mel Star,

Good point, and thanks for sharing. I tried to give the basic info without too many examples, otherwise the post would have been too long! Thanks for sharing. :)

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5 Keith Lauren

If only it was simple. FICO likes to put out these pretty little graphs that make sure think, ok great I now know how it works. unfortunatly it is infinatly complicated and you never knwo when doing the right thing is actually doing the wrong thing according to the FICO math.

Then you have to deal with car dealers, credit cards, and mortgage companies all using different variations of the FICO score so what you get from your credit report is not the score the lender uses.

At least we have it better than Canada here in the states but the deck is still stacked against us.

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6 Ryan

Keith, I did give a simplified version, because you are correct, it is complicated and there are a lot of factors that weight differently based on each person’s unique situation.

Car dealers, mortgage companies, and other lender’s often try to use their own scores because then they can use them to tweak your score in their favor. A few percentage points can mean hundreds, or even thousands of dollars in the long run.

While it may seem like the deck is stacked against us, it is till possible to improve your credit score by following these tips. It won’t happen overnight, but if you practice sound principles when dealing with credit, it will happen.

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7 Andy

Ryan is correct, these tips will provide a great overview to help you improve your FICO score. And the variation FICOs should follow.

Ryan, we have even more depth on this topic at our website with 9 free video lessons and lots of Q&As

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8 Jeff Clair

Nice information Ryan.

I agree with you that we should make regular payments to reduce our amount of debt and only open new credit accounts when absolutely necessary.

Jeff Clair

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9 MelStar

I know if you are just starting out with credit and you make a purchase it is a good idea to make some monthly payments .. I would say about 4 to five because this helps to establish a payment history and is the beginning of your credit file

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10 Ryan

deepali,

I’ve read the same thing. I think the important thing is to prove you can consistently make payments, and paying off purchases right away doesn’t establish a credit history as well as paying it bit by bit.

I made payments for several months when I got my first credit card. I made a several hundred dollar purchase, then paid the card off over a couple months, even though I had the cash to pay for it right away.

I pay everything off in full now, because I have an established credit history, and I don’t think it will hurt my score to pay my cards in full every month.

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11 deepali

Great series of posts. I recently had a conversation with the financial counselors I used to work with regarding credit scores (it’s one of the most commonly asked questions).
Here’s one interesting little thing we uncovered – paying off your credit card balance right after you make purchases (ie, before you get the monthly bill) can hurt your credit score.
It’s really quite complicated!

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12 threadbndr

One question that is driving me nuts. I actually paid off my mortgage five years ago. And now my score is DROPPING. I have actually reduced my credit card debt. And now my score is lower than it was when I had a mortgage and a nearly maxed out card. What gives???

I haven’t missed any payments or been late, so it’s not that.

puzzled …..

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13 barbara

You know, I have the same issues. I think the way it appears to work is that you should stay in debt to support the bank and credit card componies

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14 Ryan

threadbndr: There is no way for me to know your exact situation, but there could be several factors. Your score could be lower if you recently closed any accounts or applied for new lines of credit. Your score could also change if your credit limits changed because that can change your utilization rate. Another possibility is an incorrect item on your credit report, or the remote possibility of identity theft.

If it is an issue, you may consider contacting the credit bureaus, checking your credit history, or signing up for identity theft protection (if applicable).

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15 Steve C

While the information on managing your score is good, the article is garbage overall – “Having a strong credit score is one of the most important things you can do to help control your finances” – The best thing you can do to control your finances is to not buy things on credit. The only thing you should buy on credit is a house. It is probably OK to have a credit card as long as you have the money to pay the full balance. You should also have money in case of an emergency. Don’t beleive me – look at how much money you pay in interest for that status symbol tV or car you bought on credit. You will always be living paycheck to paycheck if you use credit to “control your finances.”

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16 John

Although I do not mean to insult the writer of this fine article, I do have to agree with Steve to some extent. I’m currently 32 and have had a few snafus with my credit in the past which has steered me away from using it altogether. Some finance companies are nothing short of loan sharks. Recently, I sought out a loan to purchase a relatively new car at a price of roughly $17k, putting $14k down via a 401k loan, which left $3k that needed financed with a loan from the bank. Although I have insufficient credit with no credit score – they were able to approve that $3k loan, but with a small catch. They wanted an 18% apr, even though there was absolutely no risk on their part. Even with $14,000 in hard cash equity – they wanted to slap me with an interest rate that amounted to a maxed out credit card with a $3,000 balance. I was quick to laugh at them and walk away.
I say all that knowing that lending practices have become tougher over the past couple of years. However, it was a disappointment to have such a ridiculous loan offered to me even though I was not part of the financial and housing market meltdown, and even though I was to shoulder all of the risk of that particular loan.
Today I am in the market to purchase a home, and I see that my lack of credit is an issue yet again. I intend to pay the bribe of purchasing a secured credit card to build just enough credit to purchase my first house (with a terrific fixed rate and low price). After the mortgage approval I will once again put my credit back up in the attic to collect some more dust.
I don’t mean to say that credit is a bad thing here, but I do think too many folks have the mindset that credit is absolutely essential for much of their spending. Too many financial institutions model their loans in such a way as to set their customers up for failure. Perhaps this is the ‘garbage’ that Steve was rightfully referring to when he made his comments here about credit.

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17 Ryan

John, I understand the difficulty of not being able to get a loan with a low interest rate, but to say the bank is taking on no risk in the example you gave is not true. You would have been borrowing the $14,000 down payment from your 401k, which means you were actually financing the entire purchase, not just the $3,000 you wanted from the bank. The difference is that you were borrowing the majority of it from yourself. When it’s all said and done, you would still have a $17,000 loan and the payments that go with it.

Regardless of whether you borrow $1,000 or $10,000 or $100,000, banks see no credit history or poor credit history as risk. If you need to improve your credit score, then I recommend starting small – perhaps with a smaller loan, or with a secured credit card, as you mentioned. You will find it much easier to make large purchases, such as a house, with an improved credit history and a better credit score. I wish you the best.

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18 John

Ryan,
Thank you for the suggestions in building credit. However, I have to respectfully disagree with your comment that the bank would have been taking on risk with regard to the loan I mentioned in my last post.

The fact that I borrowed from myself for the down payment is irrelevant in discussing risk to the bank providing the auto loan. So to simplify things I won’t go into that anymore here. Although I would have been financing the entire $17,000, they would have had $14,000 of hard cash on the table in the form of a down payment, leaving roughly a $3,000 balance as discussed to make payments on. Under this scenario – they should have been practically begging me to take the loan even at a 5% rate. Had I defaulted on the loan, without even making payment #1, they would have been in a position to pocket the $14k while repossessing and selling the car off at an auction to cover the balance of $3,000 and whatever other costs and fees that would undoubtedly end up getting piled on. The vehicle’s value at such an auction would have obviously been much less than the purchasing price, but shouldn’t have any trouble auctioning off for at least $6 to $8k under worst case scenario.

The loan was virtually a win/win for them regardless of my credit history. That they view poor credit as a risk does not in fact mean that risk would have existed for them with that loan. It was to their detriment that they were unable to look past the credit history issue and perhaps try to work with a potential customer who was willing to fork over 3/4 of the loan upon signing on the dotted line – while they held the title of the car as collateral.

I would suggest that all consumers use due diligence before buying into the entitlement mentality that many financial institutions appear to have in the wake of the financial crisis. Credit can be a good thing if built carefully with the proper loans and payment history, but it can also be quite crippling to the unsuspecting buyer.

Thanks again for the feedback Ryan. Lets hope things improve for the economy in general for both consumers and lenders alike.

19 Ryan

Steve C: Not only did you insult me, but you are living in an “ideal world.” Not everyone can afford to go through life without ever using credit.

Having a strong credit score can help people get access to a line of credit, which when used properly – as a financial tool and not to finance a lavish lifestyle – can be an important factor in one’s finances. Notice that I did not say it was the most important factor.

Credit by itself is not bad; it’s how one uses the credit that matters – just like other “dangerous tools.”

Earning a high credit score comes through using credit properly, not by living beyond one’s means and only making minimum payments on a maxed out credit card. I do not advocate buying more home than one can afford, or living beyond one’s means. In my opinion the most important factor in personal finance is living within your means (earning more than you spend and spending less than you earn). A good credit score can help people manage to do that.

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20 Terry C

I have a house and want buy one in a new area. I’d like to pay off my current mortgage but am reluctant to do so because there will no longer be anything reported to the credit agencies showing that I can pay back debt on time. Also, after reading that you need a good mix of credit on your report, has me question whether I should pay off my mortgage.

If I don’t find a new house for 2 years, would it negatively affect my FICO score to pay off my current mortgage now? Is there a look back?

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21 Ryan

Terry: From what I understand, completing a mortgage is very good on your credit score/report, because it shows you have the ability to pay off a major loan. I don’t think it will hurt your score at all. However, I am not an expert in this specific situation, so you may consider calling a lender or mortgage broker and asking them. Best of luck to you.

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22 Matthew Denos

Hi Ryan,
I read once in a newsletter by Scott Letourneau (of Nevada Corporate Planners) that not paying off your credit card balance in full is actually a good strategy for improving credit score. I don’t remember the reasoning behind this concept, but the point was that it is not the best practice in terms of credit score to completely pay off all your balance every month. Could that be true? Am I missing something?

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23 Ryan

Matthew, some people say that is a good way to build credit because it shows you are able to make installment payments on a loan. But the same thing can be accomplished with any installment payments, such as a car loan, mortgage, student loans, or anything else you finance. In general it isn’t a great idea to carry a credit card balance because of the relatively high interest rates. If you can get a 0% introductory offer on purchases or a low interest credit card, then it won’t be as bad on your pocket book. But I recommend everyone pay their balance in full each month.

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24 Troy

There is so much hype going on about credit scores today, but with the economy in the tank and banks not lending, I am not sure how important it is right now. For sure, subscribing to and monitoring our credit score instead of saving that money makes no sense at all.

Troy

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25 David

Why don’t you tell people with a bad credit score how to get a job so they get the credit score up? With economy down so bad along with short sales, foreclosures, while a lame duck president that’s helping to lose more jobs, and the market keeps going, lets get action going to remove the credit check out of the hands of employers for honest people who are having bad luck, trying to get back on their feet

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26 Kathy Owens

This has been very awakening and helpful to me…………Great to learn so much…I now feel more confident in improving my credit score….I had no idea that the length you’ve had your credit card was even a factor in a higher credit score. I had planned on paying off my oldest credit card (after 15 yrs.) and closing the account because it keeps being bought by other companies or banks and the interest rate goes up each time….So now I know to pay it off as planned, but keep it and NOT use it. Thanks so much for the info.

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27 Ryan

John, my recommendation is to go back to the bank where you applied for the loan and ask them to explain the high interest rate – they should be willing to explain their loan offer based on your credit history, credit score, and other factors.

If the bank was aware of your $14,000 401k loan, it may have affected their loan offer to you because they take many factors into consideration when making loan offers, including credit history, payment history, number of lines of credit, types of credit, credit utilization (percentage of available credit used), and more. In this case, your 401k loan may skew your credit utilization or otherwise affect the loan offer. But it’s impossible to be certain – we simply don’t have enough information to go on.

That said – you can still work to improve your credit score by following the methods outlined in this article. It takes time, but can save you thousands of dollars in interest payments over the years, or in the case of the house you are looking for, potentially hundreds of thousands of dollars. My recommendation is to try and delay any major purchases if possible, so you can save a larger down payment and improve your credit score, the former will reduce the amount of money you need to borrow and the latter of will give you a lower interest payment. Both will save you a lot of money in the long run.

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