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.
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:
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.
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
Lenders 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 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.