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A good credit score is essential for taking control of your financial future. It can secure you lower interest rates on loans and credit cards, increase your credit limit, and even simplify renting an apartment or getting a job.
Understanding Credit Scores
Unlock the secrets to building credit by mastering your credit score. This three-digit number holds immense power over how lenders view your ability to repay debts. Explore the factors shaping this critical number and empower yourself with the knowledge to excel in strengthening your credit.
Companies leverage data analytics to generate your credit score, with FICO (Fair Isaac Corporation) being a prominent choice among lenders. A FICO® score, ranging from 300-850, serves as a significant indicator of your creditworthiness. Scores below 670 are deemed fair to poor, while a range of 670-739 signifies good credit. Scores above this range further solidify you as a reliable borrower, with companies like FICO reporting these scores to credit bureaus.
Your credit score is calculated based on various factors including your payment history, credit utilization ratio, recently opened credit card accounts, existing debt, and mix of credit types. Notably, payment history and outstanding balances significantly impact your score—accounting for over 60% of its value.
If you are new to using credit, you won’t have much, if any, of a credit history and likely not owe anything, not allowing for much of a credit score. You will want to build up your credit so you can have the option to borrow money, if needed, for a big purchase such as a car or home or simply just getting and using a credit card.
Credit Building Strategies
Are you interested in improving or repairing your credit score? Follow these effective strategies to make progress. While it may take time, you will see your credit score increase with consistent effort. Generally, a positive impact on your score requires a 12-month history of making on-time payments. The earlier you start, the sooner you will reach your goal.
Step 1: Check Your Credit Reports
To improve your credit score, you should first know where you stand. You can get a free credit report from AnnualCreditReport.com once a year. You can also retrieve a report from each of the three major credit bureaus - Experian, TransUnion, and Equifax however there may be a cost involved. Review these reports for errors and dispute any inaccuracies you find.
In the report you will find:
- Accounts opened and the type of each account
- The date each account was opened
- Credit limits or loan amounts
- Current balances on open accounts
- History of payments
What you won’t see, your credit score. The credit history on your credit report helps determine your credit score, but this isn’t typically offered as part of your free credit report. Many banks, credit cards, and other financial services may offer you an opportunity to review your credit score at no cost. If you don’t have a free option, you may have to pay to see your credit score.
Make sure to look at each item carefully to ensure it’s accuracy. If you see something isn’t right, it might take some time to dispute the report and get it corrected.
Step 2: Pay Your Bills on Time
One of the most influential factors of your credit score is your payment history. Consistently paying your bills on time can drastically improve your score. If you have trouble remembering when to pay, set up automatic payments or calendar reminders.
Lenders need assurance you will repay the money they loan and when you have established a history of responsible borrowing by making your payments on time each month, they are more likely to approve you for a loan or credit card.
Step 3: Reduce Your Debt
Your credit utilization ratio, which is the percentage of your available credit you're using, has an impact on your credit score. It's recommended to lower this ratio by paying off debt instead of transferring it. Ideally, aim for a ratio of around 30%, meaning that if you have $1,000 in available credit, try to keep your usage below $350.
Furthermore, consistently using most or all of your available credit each month might make lenders question your financial management skills. This could make them hesitant to lend to you, as they may doubt your ability and discipline to repay them.
Keeping your debt as low as possible not only maintains a good credit utilization ratio, but also provides you with the freedom to use your money as you please, rather than using it solely to pay off creditors each month. While debt can be necessary, it's essential to manage it responsibly.
Step 4: Don't Close Old Credit Cards
Length of credit history is another important aspect of your credit score. If you close old, unused credit cards, you could shorten your credit history on your credit report and lower your score. Lenders want to see that you have been responsible for some time, and this assures them you will likely be responsible now, should they lend to you.
Additionally, by keeping older cards open that you no longer use, you will lower your credit utilization ratio. Whatever amount those cards accounted for in available credit, even if you don’t use the cards, will be counted towards calculating your ratio and potentially boost your credit score.
If an account is dormant for a certain period of time, typically the lender or bank may contact you to let you know the account may be closed due to inactivity. They will give you a date they will close the account if it remains inactive. Once you receive that notification you can determine if you would like to use the account to keep it open or allow them to close it.
Step 5: Diversify Your Credit
Mixing different types of credit can also improve your score. For instance, having both revolving credit (like credit cards) and installment loans (like a car loan or a mortgage) can show lenders that you can handle different types of credit responsibly.
An installment loan is the most basic type of loan. You borrow $1,000 and make payments (with interest) each month, for a specified period of time until the loan is paid off. Revolving credit allows you to use up to certain amount (your credit limit) and when you repay that money, it becomes available for use again. Your available credit will always be your credit limit less whatever money still needs to be paid back.
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Step 6: Limit New Credit Applications
Every time you apply for new credit, a hard inquiry is made, which can lower your score. So, limit the number of credit applications you make and only apply for new credit when necessary. There are two types of credit inquiries soft and hard. A soft inquiry is more of an exploratory inquiry that could be made by a credit card company, even without your knowledge, looking to see if you could you be approved. If so, they might send you an application in the mail to offer you to apply for the credit card. There also soft inquiries you would be aware of such as a background check or a loan prequalification check.
A hard inquiry is when you apply to borrow money and a more thorough look of your credit is taken. If you have a strong credit history and score, the chances are you will be approved. However, if you apply to Lender A and are denied and then go to Lender B and then C, your credit score will reflect this.
Additionally, if you apply to Lender A and are approved and then do the same at Lender B and C, your credit score can also go down as well due to your increasing the number of new accounts open.
Hard credit checks don’t impact your credit with any significance when they are only done occasionally. It’s when there are a series of hard inquiries in a short period of time that your credit could be negatively impacted. So, if you are tying to build your credit by applying for a lot of credit, be careful that you aren’t doing more harm than good.
Step 7: Options for Those Without Credit
If you don't have a credit history or have a low credit score, consider getting a secured credit card or credit builder loan. This can help you start building your credit while being backed by a cash deposit that you provide.
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Sometimes to demonstrate your financial responsibility you need to put your money where your credit is. Secured credit cards for example require you make a deposit (in the amount that would be your credit limit) to the credit card issuer as an insurance that the money used on the credit card can and will be repaid. After using the card responsibly for some time, with all your timely payments being reported to the credit bureaus on your behalf, you might be able to convert the card to an unsecured card (no deposit required).
Another alternative to a secured credit card is to be added as an authorized user on a family members account. By being an authorized user this will allow you to establish yourself while still under the guidance of a more experienced credit user.
A newer option rising in popularity for those looking to build their credit are third-party companies that will work with you to build your credit by reporting regular rent and/or utility payments made on time each month to the credit bureaus to demonstrate your ability to make payments responsibly and timely.
By using these steps you will be able to build your credit. Building credit requires a combination of good credit habits, such as paying bills on time and keeping balances low, and strategic credit management. With some patience and diligence, you can improve your credit and open the door to new financial opportunities. Remember, your credit score will continually change over time to reflect your current state of financial discipline —consistent and responsible behavior over time will get your score up and keep it in a good place.
