Recently, we looked over the type of information contained in credit reports, including personal information and payment history. Since credit reports are pulled by potential lenders, landlords and even employers, it is so important that you check them regularly to ensure they are accurate and up-to-date.
The credit score is another factor that many institutions will take into account when determining whether to lend you money, lease you an apartment, and what interest rate to charge you. If it wasn’t confusing enough that there are multiple credit reporting bureaus, there are even more types of credit scores. In fact, each institution can develop its own formula for computing a score according to the qualities they find most relevant.
Even the number range varies between scores, so your 800 may be excellent when the range is 350 to 850, but not as strong on a range of 500 to 990. To simplify matters, we’ll look at one scoring model, the FICO score, which is the most commonly used. It ranges from 350 to 800.
According to a survey by Trans Union, one of the big 3 reporting bureaus, there are many misconceptions about what the score is, and isn’t, based on. For instance, while employment records may be included in your credit report, your income and changes to it are no influence on your credit score. Got a big raise? Great, but it won’t do a thing for your credit score unless you use it to make a big payment and reduce your debt ratio.
What does improve your credit score?
1 – Consistently paying on time.
The fall from grace is dramatic when someone with excellent credit misses a payment. Their score will suffer a greater loss than someone with a habit of late payments.
2 – Having a low debt ratio.
This is the amount of credit being used compared to the amount available. Ideally, you want it to show that you have been extended far more credit than you have used at any given time. Ideally, try to keep the amount in use under 25 percent. Since there is no way to know exactly when each lender will report your account updates to the bureaus, this can mean that your score fluctuates during the month.
For example, we use our Discover Card extensively each month, because we earn tremendous cash back rewards, and then pay it in full before the due date. Discover has a new feature where they let customers see their FICO score at the time of each statement. Depending on when we make payments and when they are reported, my score can go up or down by 10 points, without any other variables.
3 – Having different types of accounts.
This includes both secured loans, such as a mortgage, and revolving accounts such as credit cards. This one kind of annoyed me after paying off my car loan. My score actually went down, since it no longer showed the low amount owed vs the amount of credit I was allowed on the loan. I was also penalized because I no longer had that kind of installment loan. Dave Ramsey fans will especially find this irksome as he promotes a system of not using credit, which then gives you a very unappealing credit report and score in the eye of a lender, should you need to borrow.
4 – The length of time you have held accounts.
This is where the spontaneous inspiration to “cut up your cards” can hurt you. Sure, cut them up if you want to make sure you don’t use them, but think before actually closing accounts. Each account adds to the total credit available to you. If those accounts are closed, your debt ratio in relation to the available credit will increase, hurting your score. My dad had me sign up for checking, savings and credit card accounts through a credit union when I was young. Keeping them open shows a great length of time for holding accounts. When you are moving debt around from one card to another and closing accounts (or worse, having the creditor close them), then this is reflected negatively in your score.
Why should you care about your credit score?
A low score means you will pay more for the same products and services as someone with good credit. You’ll pay installation fees to have utilities set up, while theirs are waived. You’ll pay thousands more to buy a car and tens of thousands more for a house. The credit cards you are offered will not only have higher rates, but annual fees and steeper penalties. My husband, who does not have good credit, remarked once that credit card companies still sent him a ton of offers. First of all, of course they do since by him being a higher risk, he is more likely to carry a balance and pay their steep charges. I also compared the “fine print” between the offers he received vs the ones I was sent. They were vastly different as far as interest rates and fees, balance transfer rates and penalties.
So, what is the best thing you can do to improve your credit score?
There is no fast fix. Anything promising that is a scam — trust me on that. The most weight in the score is based on making payments on time. Do whatever you need to ensure that happens for every account. If this is a problem for you, have a special account where money is automatically deposited and can’t be withdrawn except via automatic payment to the companies holding your loans and credit cards. Make it a priority, and make the payments consistently, and you will see your score improve.
Second, make larger payments than the minimums to knock down the ratio of what you owe. These two goals will impact your score the most, whether favorably or negatively.
One final note: There is some confusion over whether or not checking your credit report hurts your score. When you check your own score, such as requesting the free ones from AnnualCreditReport.com, it is called a soft inquiry and does not impact the score. When you apply for credit, such as a car loan or credit card, it is called a hard inquiry, and does lower your score a little. However, it does not count each time you apply for the same type of loan within the same timeframe. There is an understanding that you may try to get the best rate by requesting a loan at several places during your car search. If they occur within a short timeframe, these inquiries will only count as a single hit to your credit.