As you begin improving your credit score, keep in mind it’s a marathon and not a sprint, it takes patience and hard work. A poor credit score could cost you tens of thousands of dollars over a lifetime. It can also become a source of serious stress. Let’s cover how to increase your credit score!
Many people struggle to improve their credit scores, and there are ways to build good credit — and reap the rewards that come with having a good credit score.
What is a FICO score and why is it so important?
The FICO score is the calculation that gives you your credit score. There’s a lot that goes into the calculation and no one knows exactly what goes into it, but we have some general ideas. FICO stands for the Fair Isaac Corporation, which is simply a company that provides the software to calculate your credit score.
This is important because this score is what every lender will look at before deciding to give you a loan. If your score is low, you run the risk of being denied or paying high-interest rates.
The FICO score ranges and what they mean
Different companies have different scoring models but The Fair Isaac Corporation has created their scoring range from 300 – 850. Having a 300 credit score essentially means you’ve made all of the mistakes possible when it comes to borrowing money. I haven’t met anyone with a credit score in the 300s, but I know they exist. Most people fall in the 600 – 700 range.
And of course, having an 850 means your credit score is perfect. I’ve also never met someone with a perfect credit score, but they are out there and no one really knows what they did to get a perfect score because it’s not easily replicable.
The credit factors that affect your credit score and some tips on navigating these credit factors
Like I mentioned in the previous section, we don’t know everything that goes into the score but we do have general principles of things to keep in mind. To give you a general breakdown of what we think impacts the score the most, it’s broken up into 5 sections:
1. On-time payments 35%
If you miss one payment, this will have a bigger negative impact than anything else. And once you miss one it can be on your credit history forever. Make sure you make on-time payments or set up an automatic monthly minimum payment if you have to.
2. The amount of money owed 30%
This one can confuse a lot of people. It’s not just the amount of money that you owe, but the amount of money that you owe in context of how much is available expressed as a percentage rate.
For example, if you owe $2,000, it won’t have a negative impact on your score if you have a total credit limit (across all credit cards) of $50,000. This means that you have a credit usage of 4%. But if your credit limit is $2,000, well that means you’re maxed out and this will definitely have a negative impact on your score. Most experts recommend that you keep your credit usage below 30%.
Al Bingham, author of The Road to 850 recommends you keep it below 5%. I recommend that you keep it at 0% by paying off your credit cards every month. This can get tricky though because you will need to contact your credit card company and ask when they report to the credit bureaus.
In my case, my credit card companies report to each of the three credit bureaus between the 15th – 19th of each month. So, if I want my credit usage to show up as 0%, I need to make sure that all balances are paid off before the 15th.
3. Length of credit history 15%
This won’t have the biggest impact on your score but plays a big role. The amount of time that you have borrowed money is important. Think of it from the lenders perspective, would you want to lend out your nice new $60,000 BMW to someone that is just learning to drive? Of course not, it’s no different in the world of credit.
How it works is they take your average credit history, not your total credit history. Let me give you another example: Dave, who is fresh out of high school, decides he wants to open up a credit card in order to start the clock on his credit history. He buys a couple of things on his credit card and then pays it back and doesn’t open up a new credit account for five years. After five years, when he goes to apply for a mortgage, his credit history is five years.
Let’s suppose that two and a half years after high school he decides to take out an auto loan. When he goes to apply for a mortgage in five years his average credit history is only two and a half years instead of five because of the new auto loan. Most lenders like to see an average credit history of at least three years. This is why it’s important not to go borrow a bunch of money at once.
4. Credit mix 10%
The type of credit that you have borrowed also matters. There’s a difference between revolving credit and installment loans. Revolving credit is when you open up a credit card, and you can continue to use it. An installment loan is an auto loan or a cellphone contract. For example, once it’s paid off, it’s done. It’s good to have a mix of each one.
5. Inquiries 10%
Inquiries are when someone pulls your credit report when you go to apply for more credit. This could also be when you open up new accounts. Initially, it could have a negative impact on your score.
Keep in mind that there is a difference between a soft inquiry and a hard inquiry. A soft inquiry is when a company is able to check what range you fall in but they can’t see your exact credit score. They don’t need your permission to do this and this is why you get pre-approved for offers in the mail. Soft inquiries don’t have a negative impact of your score.
A hard inquiry does have an impact on your score. This is when you give someone your basic information and approve them to check your credit score. Each hard inquiry can lower your credit score around 5 to 10 points but usually comes back up pretty quick.
Depending on your state you’re allowed a short time frame when applying for a large purchase to have as many inquiries as you want without it affecting your score.
For example, if you’re applying for a mortgage, you may have 30 days to “inquire” from multiple different lenders to find the best interest rate without it affecting your score. Check with your state laws.
My #1 tip if you’re looking to get a copy of your credit report for free.
Check it every four months. You can go to annualcreditreport.com and download your credit report for free. What a lot of people think (it’s what the name of the website implies), is you can only check it once a year. That’s not true. You’re allowed to check your credit report once a year from Transunion, Equifax, and Experian. That means you can spread out when you check each one every four months. I set a reminder to check my credit report on January 1st with Transunion, May 1st with Equifax, and September 1st with Experian.
It takes two minutes to go to annualcreditreport.com and download a pdf from each credit bureau and make sure everything looks ok and there is nothing suspicious and no derogatory marks.
You can also get an idea of what your credit score is by signing up with Credit Sesame.
Why is it important to correct errors if you have them on your credit report?
It’s important to correct any errors or derogatory remarks because this could impact how lenders view you. They might look at you as high risk if something negative shows up on your credit report even if you didn’t do it. If you are classified as high risk and you have to pay a higher interest rate, this could cost you tens of thousands of dollars over the life of a loan.
What are some of the most common types of errors people should look for on their report?
Misspelled names and incorrect addresses.
What’s the best way to go about disputing an error?
Simply contact the credit bureaus and let them know that there is a mistake on your credit report. I’ve helped multiple people call and have their credit report corrected. Most of the time the credit bureaus are easy to work with when disputing errors, but sometimes it can be difficult and take months sometimes years for something to come off of your credit report. This is why I recommend checking each one every four months.
Set up a debt repayment plan to help fix their credit
Do it yourself. Many people think that they need to pay someone else to fix their debt problems. It may be worth sitting down with someone like myself and going over a plan to pay off your debt, but I don’t recommend that you give anyone power of attorney in order to contact your creditors on your behalf.
No one cares about your money as much as you do and this oftentimes results in a lower credit score, more interest and a contract that you’re stuck with.
#1 tip for people trying to build new credit
Start small and build up from there. Don’t feel like because you’re young that you need to apply for all types of credit. Ideally, if you could avoid going into debt all together this will help you get on the path to financial freedom more than anything else.
#1 mistake people should avoid when trying to build new credit
Signing up for a retail credit card because they’ll save 10%. Don’t do this. Where people make the biggest mistake is being susceptible to the thousands of marketing messages that get thrown at us every day and spending money because they’re getting “a good deal.”
Developing discipline, being patient, and sticking with a plan is what will help you the most when it comes to building your credit and increasing your credit score.