How To Improve Your Credit Score: Credit 101
Why Should You Improve Your Credit Score?
Sure, it’s nice to have a higher 3-digit number than your brother-in-law, Karl, but you’ve never had trouble getting a loan or buying a home. Why should you care whether your credit score is 387 or 783?
Credit scores determine more than whether or not you’re approved for a loan. They heavily influence what sort of interest rate you’re likely to pay and even what sort of terms you’ll be offered. Those aren’t just vanity issues – it can mean a difference of thousands of dollars a year. And those are just the uses for which they’re at least sort of intended.
Credit scores are often checked by potential employers who believe they say something about whether or not you’re likely to be a reliable employee. They impact your insurance rates. They can be the difference in whether or not you’re approved for an apartment. Credit scores are checked for all sorts of things they weren’t designed for.
I’m not suggesting you build your life around them or anything, but neither should credit scores be readily dismissed. What you do with that information is, of course, entirely up to you.
How Do You Improve Your Credit Score?
We’ve been talking recently about what a credit score is, what sorts of information is used in credit reporting and overall credit score statistics in the United States. Along the way, we’ve discussed a few ways to improve your credit score (as well as a few flashy promises to avoid). Several of you have asked if we could spend a bit more time on that topic – practical ways to improve your credit score – and of course, I’m happy to oblige.
How to Improve Your Credit Score?
As you probably realize, not all credit scores are the same. The FICO is computed somewhat differently from the VantageScore, and the finance guy at the car dealership cares about slightly different things than the folks handling your mortgage or the lady deciding whether or not to rent you an apartment.
For the most part, however, the steps you take to improve your credit score should help you across the board, improving all credit scores computed for you, by pretty much anyone, and for whatever purpose. Keep in mind that you don’t need a perfect score to get great terms from lenders. Anything over 740 or 750 is considered “excellent,” and even scores below that can qualify you for decent interest rates if you’re willing to shop around.
And don’t get discouraged if your credit score isn’t what you’d like it to be right away. Maybe you’ve made mistakes in the past, or been hit with unexpected circumstances. We can’t change that, but we can move forward. Your goal should be to improve your credit score from where it is now. Once you’ve done that, you can plan your next steps and keep going. There’s no time like today to begin.
For what it’s worth, I’ve been there, and I believe in you 100%. I seriously do.
Let’s start with the most obvious and reliable things:
1. Pay Your Bills On Time
I realize this is easier said than done. There are many different reasons we don’t keep up our monthly payments, however. Sometimes the problem is that we’re simply not making enough to cover everything we owe. If you’ve put together a household budget and done the math, and this is you, don’t just keep hoping from month to month that the Money Fairy will show up and make it rain twenties one morning as you’re shaving.
That almost never happens.
Bill Consolidation Loan
If your income can’t cover your “out-go,” you need more income or less “out-go.” One possibility is a bill consolidation loan of some sort to pay off multiple credit cards, medical bills, or other outstanding debts. You’ll still be paying back the money, but hopefully at a better interest rate and with one monthly payment instead of twelve.
Cut Your Spending
Other options included cutting back on your current cable or cell phone packages, paying attention to how often you’re eating out, making impulse purchases, or otherwise bleeding cash for things you can’t even remember at the end of the week.
For some of us, it’s not even a matter of making enough. I had a bad habit of letting bills pile up on my desk with every intention of paying them, then I was busy one weekend, distracted the next, and before I knew it, my car payment was late and I was getting anxious emails from my credit card providers. Back when I was digging myself into serious financial difficulty before I really crashed and burned, I used to take the family out to eat and maybe hit the mall on payday. I wanted us to have a little fun before I had to pay bills and risk discovering that we couldn’t afford a shopping trip to the mall that particular week.
Hey, it felt like it made sense at the time.
It didn’t.
Organization Is Key
In other words, sometimes the issue isn’t financial so much as it is organizational. Keep up with your mail and your email notifications. Pay your bills. Every time. On time. Besides, taking care of these sorts of things is about more than trying to improve your credit score. It’s part of responsible adulting. You want the right to stay up as late as you want and eat ice cream for breakfast if you so choose? Fine – but you also have to call the cable company and figure out why they charged you twice for NHL Center Ice this month.
Making your payments on time doesn’t actually win you any points with the credit reporting bureaus, but getting reported as 30+, 60+, or 90+ behind definitely hurts. Pay those bills, kids.
2. Check Your Credit Report(s) for Errors
As we’ve discussed before, your credit report may look different depending on which credit reporting agency runs it. With the huge amount of information being juggled and parsed, errors do sometimes happen.
You can check your credit report from all three of the major agencies for free. Read through each one, carefully, and make note of anything that doesn’t sound right. Check all credit scores to see how they compare; they should be in the same range, even if they vary from agency to agency.
If you find an error, start by digging up any documentation which might support your claim. That “paid in full” letter, an email clarifying your balance on something, or even the original signed agreement may prove helpful. Don’t panic if you can’t find everything, but the better your documentation, the easier it usually is to resolve the error.
Credit Report Basics Explained
Contact the reporting credit agency or agencies. I suggest actual written correspondence through the mail, and of course keep copies of everything you send and any replies you receive. Each of the credit reporting agencies has information on how to do this on their websites. Include relevant specifics, but remain professional and don’t let your emotions get in the way. Your goal is to resolve the error, not convince them you’re a good person or to accuse them of anything. Most errors are just that – errors. Something got typed in the wrong way, reported incorrectly to begin with, etc. If anyone’s “out to get you,” it’s probably not Equifax, Experian, or TransUnion.
Next, contact the reporting institution. Someone submitted that information, and you want to attempt to clean it up at both ends. I still suggest actual written correspondence, but if you choose to do phone calls or online chats or whatever, take notes as you go about the time and date you reach out, who you’re talking to, and exactly what they tell you. Again, it’s not about anyone trying to “ruin your life” and you shouldn’t be trying to ruin their day; the goal is clarity and accuracy all ‘round.
3. Don’t Max Out Your Credit Cards
Another one in the “easier said than done” category, right?
Part of computing your credit score is something called your “credit utilization ratio.” While FICO and VantageScore weight it differently, all credit scores treat it as a substantial factor.
Let’s say, for example, that you have two credit cards – one with a $2,000 limit and one with a $5,000 limit. You currently owe around $1,800 on the first and $4,350 on the second. Even if you’re making your minimum payments on time and staying under your limit, you have a poor credit utilization ratio. You’re using MOST of your available credit. If you needed access to more funds, you’d have to look elsewhere, because your cards are nearly maxed out.
In our second example, you have those same two cards with the same credit limits. You owe $900 on the first one and $1,750 on the second one. I’m sure you won’t be surprised to hear that this is a MUCH better credit utilization ratio.
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What might surprise you is the third example. You have two credit cards and your balances are the same as in the first example - $1,800 and $4,350. The difference is, the first card has a limit of $7,500 and the second card a limit of $15,000. Of the three scenarios, this one demonstrates the BEST credit utilization ratio. You’re using less than a third of your available credit on both cards, which helps your credit score substantially. Even though you could conceivably go into way more debt, you haven’t. Plus, if there’s an emergency, you have funds available to cover it.
This is why many advisors suggest you keep your cards open even if you pay them off and don’t intend to use them again. It’s an easy way to improve your credit score. Personally, I leave that up to you. You know yourself, and you know whether or not you can let a card sit in your safe or at the bottom of your purse or hidden in your wallet for true emergencies, or whether you’re likely to whip it out and start impulse spending at the worst possible time. Sure, it’s nice to have open cards to help your credit utilization ratio. They only help, however, if you don’t max them out again in a few months because you figured “one night out” wouldn’t hurt.
4. Apply for Credit When You Need It. Don’t Apply for Credit When You Don’t.
What I mean by this is that you should try to “act normal” when it comes to credit use over the years. If you’re one of those rare folks who pay cash for your home, for every car you buy, for vacations, medical bills, and back-to-school shopping, more power to you. But you’re not going to have a very good credit score because you haven’t demonstrated an ability to responsibly manage debt.
Before anyone gets defensive or throws things at the screen, please understand that I’m not making a personal judgment. I’m simply telling you how lenders and the major credit reporting agencies process your credit history. If you don’t ever borrow and repay, you can’t improve your credit rating. You may not even have one.
If that’s you, and you’re beginning to think maybe you should improve your credit score, there are a few practical ways to establish that history:
Take Out a Loan
The most obvious way is to take out a loan to buy stuff people normally take out loans to buy – a new truck, a home improvement project, etc. This should, of course, be something you were going to do anyway. (I’m not suggesting you buy a car you don’t want just to build a credit history.) And, of course, this only works if you make your payments in a timely manner, which I’m guessing won’t be a problem.
Open An Emergency Credit Card
Consider a credit card for emergencies, and to help you establish a credit history of some sort. You can use it for a few normal purchases over the course of a few years, and pay it off regularly. I’m not encouraging you to pay outrageous interest or go into crippling debt for no reason. There are times, however, that having that little plastic key to flexibility in your wallet or purse can be a real lifesaver.
Don’t apply for loans just to apply, however, and don’t open cards randomly in hopes of gaming your credit utilization ratio. Concentrated bursts of credit activity don’t help your credit score. Lenders are looking for predictability and reliability – hence my encouragement to “act normal.” Someone with a limited credit history who’s suddenly applying for multiple credit cards and personal loans makes them nervous – and rightly so. If you, however do decide to take out a loan, and are looking for a reputable lender, we can help you find one. If you fill in the required information below, we can quickly match you with a suitable lender.
Hard Inquiries Vs. Soft Inquiries
We should probably distinguish between “hard inquiries” on your credit report and “soft inquiries.”
A “hard inquiry” is made when you’re actually applying for credit – you’re trying to buy a car or take out a department store card or otherwise secure a loan. These show up on your credit report and impact all credit scores to some small degree. They’re not “bad,” however, as long as they seem like normal credit inquiries.
“Soft inquiries” are done by employers checking your credit rating as part of the hiring process, or when you check your own credit reports. These don’t impact your credit scores or even show up on your credit reports. They’re “freebies.”
5. Guard Against ID Theft
It’s an unfortunate reality of modern life that anyone serious about protecting or improving their credit score should enroll in some form of credit protection. There are simply too many major breeches and any number of smaller headaches to keep up with alone. I wish I didn’t need a home security system and I wish I didn’t need to hide my valuables when I park at a hotel or restaurant, but in the 21st century I’d be foolish to let either of these slide. If wishes were horses and all that…
And honestly, in the grand scheme of things, it’s relatively easy to substantially improve your odds when it comes to protecting your credit history and your identity. I promise.
6. Credit Rebuilding Tools
If you’re not trying to improve your credit score so much as save it from the fiery depths of despair and destruction, you may have to take a more aggressive approach.
Secured Credit Cards
These work like any other credit card except for one key difference. You deposit an amount with the lender which could be used to cover some or all of the credit limit of the card. In other words, if you take out a secured credit card with a $500 limit, you begin by giving the card issuing institution $500 to hang onto for you. That way, if you miss a payment or default on the card, they’re covered – they simply take the amount from your deposit.
The benefit to you is that you use the card just like you would any other credit card. Most importantly, you make sure you make your payments on time each month. You don’t have to pay the balance in full, but you pay more than the minimum and you keep that credit revolving and active. In terms of credit reporting, a secured credit card is treated like any other credit card. Over time you build up a little good credit, and hopefully begin qualifying for cards with higher limits and lower interest. Eventually, you can even get your original $500 back.
“Credit-Builder” Loans
These are similar to secured credit cards, but you don’t have to make an initial deposit yourself. Instead, the lending institution makes a deposit for you into a secured savings account under your name. You can’t get to it, however, until you make the agreed-upon number of payments, which are usually spread out over a relatively short time period, like 6 or 12 months. Once you’ve “paid off” the loan, you get the money in the account.
Keep in mind that you’re paying interest on money you can’t access until after the loan is paid in full, and there are often other fees and charges as well. Late penalties can be particularly tricky for these sorts of loans, so pay attention to the small print and don’t be afraid to ask questions. This isn’t something you’d want to do if you have other options to improve your credit score, but for those of us who know what it’s like to have truly crashed and burned, these can be great tools to gradually get back in the game.
Co-Signers
If you don’t have sufficient credit for loans when you really need them, consider a co-signer. This is someone with much better credit than you who agrees to share legal responsibility for the loan with you. Ideally, this means they sign the same forms you do, you get the loan, and you make all the payments on time and they never have to think about it again. Your credit improves because you’re making those payments successfully, and everyone’s happy.
The danger, of course, is that if you fall behind on your payments, the lender has the right to demand that your co-signer cover the payment. The negative reports resulting from your delinquency will damage their credit rating alongside yours. That’s why you should be careful with co-signing. Most of us turn to family or long-established friendships – people who love you and will do whatever they can to help you out. Don’t risk damaging those relationships by being careless, my friend. Rebuilding credit isn’t always easy, but rebuilding trust can be far more difficult and the loss felt much more deeply.
One variation of this is to ask a family member or good friend who has excellent credit to add you as an “authorized user” of one or more of their credit cards. As they continue to use the card(s) and make their payments, you’ll gain indirectly from their already solid habits. I confess that I don’t personally love this one, but there’s nothing specifically “wrong” with the approach. It does border on “gaming the system,” however.
7. Don’t Do Anything
OK, I’m partly kidding on this one – but only partly. If you simply avoid excessive debt, avoid delinquencies, avoid any new problems or sending up any other “red flags,” bad information already on your credit report will eventually fall off and your credit score(s) will rise as a result.
It does point to the reality, however, that sometimes our scores evolve for reasons beyond our immediate control. For example, average credit scores across the U.S. are up (the current average FICO is 706!) and a higher percentage of consumers have hit the “perfect” 850 score than ever before. There are multiple reasons for this, some of which are about individual choices and some of which aren’t. As The Washington Post recently explained,
Since reaching a bottom of 686 in October 2009 during the Great Recession, the national average FICO score has been steadily increasing. {The Vice President of Scores and Predictive Analysis at FICO, Ethan} Dornhelm said the key drivers of the improvement in scores have been the U.S. economic recovery, consumer credit educational efforts and an initiative by the credit bureaus that has led to certain accounts in collections being removed from people’s credit files…
“It’s been a pretty stable and growing economy over the last 10 years, driving things like lower unemployment, which in turn drives consumers being in stronger financial health,” Dornhelm points out.
At the same time, it’s not all changes in consumer behavior:
Some consumers may have seen a boost in their scores because negative information has been removed. In a report last year, the New York Federal Reserve said collections accounts — which are unpaid debts sent to collection agencies — became more prevalent between 2008 and 2012 as Americans went through financial hardships stemming from the Great Recession.
The Federal Reserve noted that the decline in collections accounts was the result of an initiative launched by the three major credit bureaus — Equifax, Experian and TransUnion. Under the plan… the credit bureaus agreed to remove certain debt information from consumer files — including civil judgments, tax liens, and traffic and parking tickets or fines. The initiative also called for the deletion of previously reported medical collections that had been paid or eventually covered by insurance…
There was an average credit score increase of 11 points during the quarter the collections accounts were removed. Some individuals saw their credit scores increase by more than 30 points.
Finally,
That said, you absolutely have the power and the ability to begin making changes today to dramatically improve your credit score. If nothing else, try a few of the things described above and check again in six months to see whether or not the difference is noticeable. I assure you, it’s a good feeling.
As always, we’re happy to be a part of the journey, should you so choose. Let us know if we can help.