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Raise Your Credit Score
Credit score is a central component to personal financial success. Having a clean credit report and high credit score opens the door to plenty of opportunities like qualifying for great rates on credit cards, better rental housing options, lower interest mortgages, insurance discounts, and more.
If you lack strong credit right now, it’s possible to improve. It takes consistency and financial prudence, but the sooner you start addressing problems with your credit, the better you’ll position yourself for the future.
Before we go deeper into credit score, let’s take a quick look at the credit bureaus.
The Credit Bureaus
The credit bureaus gather all account information from creditors across the country and analyze it to calculate each creditor’s credit score. The three bureaus are:
These bureaus all use a complex mathematical model called the Fair Isaac Corporation (FICO) scoring model to calculate your score.
Often, each bureau will assign you a slightly different score. This is usually due to differences in the information each bureau has about you. Still, scores shouldn’t vary by more than a few points.
Additionally, the bureaus’ scores will differ from scores you see on sites like CreditKarma. Credit monitoring sites use different scoring models.
Five major factors impact your credit score:
- Payment History (35%): Payment history is the most critical credit score determinant. It summarizes how timely you are with payments. Even one late payment can raise red flags to lenders, thus hurting your score.
- Credit Utilization (30%): Your credit utilization ratio is the total balance across all your credit cards relative to your total credit limit. However, the bureaus factor in credit utilization for individual cards as well.
For example, if you have a $10,000 limit across three cards, and a balance of $1,000, $2,000, and $3,000 on each card, respectively, your credit utilization ratio is 60% ($6,000/$10,000). But let’s say that, on the first card, your credit limit was $3,500. That card’s ratio would only be about 28.6%.
Most recommend aiming for a 30% credit utilization ratio. So although your total ratio would be high, that first card’s ratio would be right on target.
- Credit History Length (15%): Payment history and credit utilization alone don’t paint the whole picture. For example, a college student might open their first credit card, buy $150 of groceries for the month and nothing else, then pay off $125. That student has excellent credit utilization and payment history, but they’ve only made one payment. That data isn’t very sound. Thus, the credit bureaus also consider how long you’ve used credit. Credit history length factors in the ages of your oldest and newest accounts, respectively, and the average age of all credit accounts.
- Credit Mix (10%): Credit mix considers the diversity of credit account types you have. It demonstrates proficiency in juggling different debt types. For example, someone with two credit cards, an auto loan, a student loan, and a mortgage has a better credit mix than someone with only three credit cards. Lenders assume the former’s more experienced at managing debts.
- Hard Inquiries (10%): Lastly, we have hard inquiries, which occur when a lender makes a formal request to look at your credit score before making a lending decision. A hard inquiry occurs when a lender takes a formal look at your credit report. They hurt your score slightly. It may seem odd that you’re penalized for applying for new credit, but to lenders, hard inquiries create uncertainty. Perhaps you struggle to manage your money, and you rely heavily on debt. Maybe you’re close to maxing out your credit card and need a new one. Studies have shown a moderate correlation between the number of hard inquiries and the applicant’s likelihood to declare bankruptcy. Fortunately, a hard inquiry’s effect fades over time. Hard inquiries then disappear from your report after two years.
Now that you know each component of your FICO credit score, let’s explore how you can put in on an upward trend.
Steps to Improving Your Credit Score
Improving your credit score involves analyzing how well you’re doing in each of the five credit score factors and addressing problems in each one. Keep reading to learn more.
Pay On Time
Pay all of your bills in full and on time. That includes housing, utilities, car payments, credit cards, and more. Remember, payment history is the most important credit score factor.
Your credit score will steadily rise over time — thanks to both payment history and credit history lengths — assuming you maintain a moderate credit utilization. Plus, you’ll avoid interest and late fees.
Fix Mistakes on Your Credit Report
Your first step (beyond paying on time) is to get copies of your report and then review them for errors, inaccuracies, and mistakes. By law, you are entitled to one free copy of your credit report from each of the three leading bureaus per year.
While reviewing your reports, identify any mistakes. Maybe your name is misspelled, or perhaps an outstanding account you’ve already paid off is still there. The latter is killing your score — removing it will give you a fast credit boost. Contact the reporting bureau with the incorrect item and have it removed. These days, you should be able to file your dispute online with each bureau. If not, you’ll have to call the bureau or dispute via mail. Responses to your disputes can take 48 hours to 30 days, depending on the issue, so dispute errors right away. The worst that can happen is the bureau tells you “no”.
Pay Down Your Balances
If you have credit cards with high balances, pay those down as quickly as possible. Not only will it help your score, but you’ll reduce the amount of interest tacked onto your balance.
If you only have 1-3 cards with high balances, you have two choices:
- Debt snowball: Pay off debts in ascending order of principal balance, starting with the smallest. Doing so gives you momentum.
- Debt avalanche: Pay off debts in descending order of interest rate, starting with the highest-interest debt. Doing so saves you on interest charges and ultimately has the best economic result.
Any more than three cards, though, and these strategies don’t work too well. You’ll make good headway on one card, but the balances on the other cards will climb dramatically over the long time it takes to pay everything down. You may have to modify one of the above payoff strategies to attack two cards at once.
Keep using your cards once you pay them down — just maintain a moderate level of spending. Lenders want to see you using the cards responsibly.
Of course, credit utilization is bidirectional. Paying down debts isn’t the only way to lower utilization.
Request Higher Credit Limits
Requesting an increase in your credit limit raises the credit utilization ratio’s denominator, driving down your utilization. In general, you can request a credit limit increase every six months — assuming you maintain a reasonable balance and stay in good standing.
Keep in mind that requesting a credit increase is the same as applying for a new loan/credit product. Your lender will run a hard inquiry, slightly damaging your credit in the short-term. It will pay off over time, though, as you can carry a higher balance without raising your utilization to dangerous levels.
With that said, some card issuers automatically increase your credit limit every 6-12 months. These automatic bumps don’t trigger hard inquiries.
Negotiate Your Debts
Accounts that have gone into collection weigh down your score significantly. If debt collectors are calling you regarding your accounts in collection, answer their next call. Discuss your options and try to negotiate your debt down to a more reasonable amount. Get everything in writing so the collections agency can’t renege on anything.
Accounts in collection typically stay on your report for seven years and do significant damage, although the damage fades. However, you can ease the credit hit a bit right now by ensuring the account is marked as “paid” on your report. If you agree on a payment account with the collections agency, ask them to send an official letter to the bureaus telling them to remove the account — and make sure you get a copy. If they agree, the bureau will mark the account as paid/settled when they receive the letter. Do not expect the debt collector to have the item removed automatically, as they are not bound by law to do it. You must ask them to do it.
That takes care of most actions you can take to raise your credit score. Now, it’s mostly a matter of staying the course.
Don’t Close Your Accounts
Closing your accounts and ceasing credit use can negatively impact your credit, too. Remember, credit score exists to demonstrate your ability to use credit wisely. If you have no credit accounts, lenders have no proof of your creditworthiness.
Keep your credit cards open and use them wisely — in other words, only for spending you have to do regardless of whether or not you use a credit card. If most of your debts were loans, and you’ve been using debit cards all of this time, then you may need to open a credit card and use it regularly.
How Long Does it Take to Improve Credit Score?
Minor credit score increases can take at least 1-2 months, as most lenders report information to the bureaus once a month (if not more infrequently). For example, if you drop your utilization from 60% to 20% today, you may have to hold off using your better score to open a new credit card until next month. Significant improvements will take longer, especially if you have derogatory marks (such as collections) that stay on your report for years.
Is there a faster way to do it? You may have seen ads for credit repair companies online, but can they truly bring your credit up to snuff fast? Let’s find out.
Should You Use a Credit Repair Company?
Credit repair companies are legitimate enterprises that help people fix up their credit reports every day. However, some think these firms can wipe outstanding accounts clean to provide financial breathing room.
This is not the case. Credit repair companies help consumers with error-ridden credit reports dispute inaccuracies with credit bureaus and clean things up. They can also monitor your credit and alert you to changes. They can’t get lenders to cancel debt. In other words, credit repair companies do the same things that you can do on your own, but you have to pay for it.
Ultimately, you have to weigh time savings against money savings. If you’d rather not spend time corresponding with credit bureaus and monitoring your report, you can hire a credit repair firm. But you can do it yourself if you’d prefer to save money.
A healthy credit score is a natural result of good habits and intelligent financial decision-making. Live below your means, use credit cards wisely, pay your bills on time, and check your credit report every year. Over time, your score will rise accordingly, opening numerous doors for you.
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