Perhaps the most common question I hear as a credit expert goes something along the lines of this: “John, what do I need to do in order to improve my credit scores?”
It is a fair question, and a wise one considering your credit has a tremendous influence over your financial life. However, as is the case with many credit related questions, there is not one simple answer.
Setting out to improve your credit reports is not a sprint and there are no shortcuts you can take to move your credit from “bad” to “great” overnight. Still, if you are willing to study and learn the steps you need to take and commit to a lifestyle change then there is no reason why you cannot see a potentially tremendous improvement in your credit over the next few years. Here are 10 tips to help you get started:
1. Pay Attention
You have a reasonable right to expect the information contained in your credit reports to be accurate. In fact, the Fair Credit Reporting Act (FCRA) signed into law in 1970 has given you this right in plain black and white for over forty years. Yet even though you have been given the right to expect error-free credit reports, the truth is that errors still occur every single day.
There is only one person who is truly qualified to ensure that your credit reports reflect accurate information, and that is you. It is your responsibility to check the information contained in your credit reports for errors. When errors do occur the FCRA gives you the right to dispute those errors; however, you will never know that there is an issue in the first place if you do not get into the habit of routinely checking your credit reports.
Since 2003, as part of the Fair and Accurate Credit Transactions Act (FACTA) amendment to the FCRA, you have had the right to access a free copy of each of your 3 credit reports every 12 months. These free federally mandated reports are available to you via the website www.AnnualCreditReport.com. In addition to these free reports many states afford you even more free credit report access. But, these rights are reactive meaning you have to actually ask for a copy of your credit reports. The credit bureaus aren’t going to send them to you without you first asking.
2. Understand What Matters
Credit scoring models like VantageScore and FICO pay attention to certain aspects of your credit reports. For example, it is true that having your credit reports pulled by lenders too often can damage your credit scores. However, paying your bills late could cause much bigger problems.
Understanding the individual importance of each credit scoring category can arm you with the knowledge you need to make better credit management decisions in the future. Scoring models break your credit reports down into five separate categories, each of which are considered separately when calculating your credit scores. The categories each account for a different percentage of your overall credit scores, so some categories matter more than others. The categories are:
Payment History – 35% of Credit Score Points
Amounts Owed – 30% of Credit Score Points
Length of Credit History – 15% of Credit Score Points
New Credit – 10% of Credit Score Points
Mix of Credit – 10% of Credit Score Points
3. Be On Time
As you can see, when calculating your credit scores the most important factors have to do with your payment history. The main purpose of credit scoring models is to help lenders predict the risk of you becoming late on any of your credit obligations in the future.
It shouldn’t surprise anyone that the most important category of your credit reports is how well or how poorly you pay your bills. Late payments indicate to your current and future lenders that you are not a good credit risk and that loaning money to you could potentially be a bad investment on their part. For this reason it is simply impossible to ever achieve a great credit score unless you are committed to making payment on time.
Late payments are allowed to remain on your credit reports for up to 7 years per the FCRA. However, although late payments have a fairly long credit report lifespan the negative impact these late payments have on your scores does lessen over time. As a result, a late payment you made on a credit card account 5 years ago is not going to inflict nearly as much credit score damage as a late payment you made last month.
4. Give Your Budget an Overhaul
Overspending is one of the biggest causes, if not the biggest cause, of credit problems. When you begin to justify a lifestyle of spending more than you can afford then it is only a matter of time before your credit reports and scores begin to reflect these poor choices. The best way to tackle an overspending problem is to begin by taking a look at your monthly budget.
It is important to have a written budget that you use to track your income and expenses on a monthly basis. If you have developed a bad habit of overspending then you can use your budget as a tool to help you figure out where your spending can be curtailed. For example, you might find that giving up your daily Starbucks addiction could add an extra $140 to your budget each month that could then be used to pay down some of your costly credit card debt.
5. Eliminate Credit Card Debt Once and for All
You can see that the second most important credit scoring category is the “Amounts Owed” category. This category is all about the amount of debt appearing on your credit reports with special emphasis on your credit card debt. Most important in this category is a metric called the revolving utilization ratio.
Your revolving utilization ratio is the relationship between the balances on all of your credit card accounts and the limits on your open credit card accounts, expressed as a percentage. The higher the percentage, the lower your credit scores. It’s that simple.
For example, if you have a credit card with a $10,000 limit and you owe $7,500 then your revolving utilization ratio on that account would be 75% and could be damaging your credit scores. However, if you were to pay off that card and keep the balance at $0.00 then your revolving utilization ratio would fall to 0% and your scores would benefit, perhaps significantly.
6. Stop Being Afraid of Credit
The truth is that carrying credit card debt is a bad idea and can lead to serious financial and credit problems. However, credit cards are not inherently bad, despite what the haters would have you believe. If you have sworn off credit cards due to a bad experience in the past or because your favorite financial guru told you that credit cards are the embodiment of evil you should probably take a moment to rethink your position.
Credit cards are a powerful tool you can control. Credit cards have the ability to improve your credit and, by extension, to improve your entire quality of life. Maintaining open, current credit cards with $0 balances and making the decision to never charge more than you can afford to pay off in a given month can go a long way to set you up for great credit scores in the future. And if you think about it, credit card usage is 100% optional which means getting into credit card debt is also 100% optional.
7. Do Not Close Unused Credit Card Accounts
Want to accidentally cause tremendous damage to your credit scores practically overnight? If not then you should be extremely cautious about closing any of your open accounts, specifically your credit card accounts. Closing credit card accounts can very easily send your credit scores sliding in the wrong direction. Here’s why…
As mentioned above, your revolving utilization ratio is the relationship between the balances on all of your credit card accounts and the limits on your open credit card accounts. If you close a credit card account, that zero balance will no longer be considered in the calculation of your aggregate (aka overall) revolving utilization ratio. When you close a zero balance credit card account you also lost the value of the credit limit in the calculation of the ratio, which is really where you can hurt your scores. Think about it…if you had a $10,000 unused credit limit and you closed the card then you’d eliminate $10,000 in the revolving utilization ratio, which is what scoring models will do.
8. Look at the Mix of Your Credit
The “Mix of Credit” category accounts for about 10% of the points in your credit scores. While 10% may not sound like much, it could be the difference between a good score and a great score. This category should not be ignored if you want to earn stellar credit scores.
In order to earn more points in this category it is important to demonstrate that you can successfully manage a variety of different types of credit obligations. For example, it would serve you well to have as many as possible of the following types of accounts reflected on your credit reports (open or closed): credit card, mortgage, auto loan, installment/personal loan, student loan, etc. You do not have to rush out and take on unnecessary debt in order to boost your scores but as you open these types of accounts, organically, your scores will benefit.
9. Stop Applying for Credit Unnecessarily
All credit scoring models pay attention to how often you apply for new credit. When you apply for credit an inquiry will appear on your credit reports as a record any time your information is accessed. Some inquiries are not considered by scoring models but others are fair game. To be safe, it’s best to only apply for credit when you actually need it despite the fact that the “inquiry” category is worth only about10% of the points in your credit scores.
Even though inquiries do have the potential to lower your credit scores, they have a relatively short credit reporting lifespan. Inquiries only remain on your credit reports for 24 months and are only considered by scoring systems for their first 12 months on file. After 12 months all inquiries are ignored.
10. Ask a Loved One for a Favor
Credit scoring models reward consumers who have been in the credit game for many years. It is pretty easy to understand why. If you have maintained a long history of great credit management habits then you are a less risky borrower from a lender’s perspective. If, however, you’re new to the credit game and just dipping your toe into the credit pond for the first time you’re a riskier prospect for a lender.
While it can be somewhat difficult to see an immediate increase in the age of the accounts on your credit reports (you can’t accelerate time and you cannot help having younger credit reports when you’re first starting out) it is not completely impossible either. Many credit card companies actively report account activity to the credit bureaus for both primary credit card holders and authorized users. So, if you can convince a loved one to add you as an authorized user to his existing, older credit card accounts, you could potentially see an improvement in the average age of accounts on your credit reports as well. Just be sure that the account has a low balance and has never been late or the account could potentially hurt your credit scores rather than help them.
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