How to Improve Your Credit Score
FICO (Fair Isaac Corporation) scores are designed to be an independent standard measure of consumer credit risk and are commonly used by lenders when making decisions about things like giving you a credit card, a mortgage or a car loan. A good score can get you better rates while a bad score can result in you paying more or not getting a loan at all. Knowing this, it’s obviously beneficial for you to know how to improve your credit score.
FICO scores are calculated from a range of 300 to 850. According to Equifax, the range of credit scores are as follows:
- Poor: 300 – 579
- Fair: 580 – 669
- Good: 670 – 739
- Very Good: 740 – 799
- Excellent: 800 – 850
Higher scores are rewarded to people generally with long credit history, low credit usage and on time payments. On the other hand, lower scores may be the result of extensive use of credit and late payments.
New FICO Credit Score
Announced in January 2020, the new FICO 10 system is expected to be introduced later this year. FICO estimates that about 110 million consumers will see a change of less than 20 points to their score under the new credit score model. Overall, roughly 80 million consumers will see a change in score of 20 or more points in either direction — upward or downward — according to FICO.
The new scoring model will likely create a wider gap between those who are considered good credit risks and those who are not. The new score will also monitor the use of personal loans, which are generally considered more risky since these are typically not collateralized by a house or car.
How Credit Score Is Calculated
If you want to improve your credit score, it’s important to understand how it is calculated. Five categories of data are used for the calculation. The breakdown is as follows:
35% = Payment History. Lenders want to know whether you have paid your bills on time. Having late payments or collections on overdue bills will negatively impact payment history.
30% = Debt Level. The amount of debt you have compared to your credit limit is referred to credit utilization. If you are currently using a lot of your available credit, a lender may interpret that as a higher risk of default. So a higher credit utilization will hurt your credit score.
15% = Length of Credit History. Having a longer credit history will improve your credit score because it gives more information about your spending habits.
10% = Inquiries. Opening several credit accounts in a short period of time will hurt your credit score since an inquiry is made each time you apply for credit.
10% = Credit Mix. Your ability to manage different types of credit (credit cards, auto loans, mortgage loans) will be viewed favorably by lenders.
How to Improve Your Credit Score
Now that you know what data is being used to calculate your credit score, the main question is how you can improve your credit score. First and foremost, it is important to know that improving your credit score takes time. So the sooner you begin to repair your credit the faster your credit scores will go up.
Here are some things you can do in order to improve your credit score:
1. Check your credit report and fix any errors
Obtain a copy of your credit report from all three credit reporting agencies (Equifax, Experian and TransUnion). Verify that the accounts and activity on those reports are correct. Carefully review the reports to see if there are any errors and contact the bureaus immediately to dispute any inaccuracies.
Checking your own credit does not negatively impact your credit score. Fixing any errors should be the first step in improving credit scores. You can also sign up for a credit monitoring service to minimize the chance of having future mistakes on your credit report.
2. Pay all your bills on time
Set up automatic recurring payment features or create calendar reminders to pay all your bills (mortgage payment, credit card, utilities, etc.) before their due dates. We all get busy sometimes with our daily lives and things fall through the cracks. The last thing you want to do is to forget about paying bills on time and have them become delinquent. This is especially important since 35% of your credit score relates to your payment history.
3. Keep credit utilization rate below 30%
Lenders calculate the credit utilization ratio by adding up your credit card balances and dividing that amount by the total credit limit. For example, if you charge $350 on your credit card every month on average and your total credit limit is $1,000 for all your credit cards, then your credit utilization is 35%. Always try to keep this ratio below 30%. Anything above that may be an indication to credit agencies that you are taking on more debt than you can afford.
4. Only apply for credit when needed
Some people may be tempted to apply for more credit cards as a way to improve their credit utilization ratio. Applying for a lot of credit within a short time frame may convey to credit agencies that you suddenly need a lot of credit. You probably don’t want to give the impression that your financial situation has changed, since it may increase your risk profile. In addition, credit card companies will make a hard inquiry into your credit report to assess your creditworthiness. Hard inquiries will negatively impact your credit score.
5. Keep unused credit cards open
There is no reason to cancel unused credit cards. In general, credit scoring models will reward you for having a longer credit history than a shorter one. Besides, cancelling a credit card may increase the credit utilization ratio. By keeping unused credit cards open, the ratio of outstanding debt as a percentage of available credit will be kept lower.