You know that adults should care about credit scores. You know that credit scores are a real thing. But do you know how to improve your credit score, or why your score matters?
What is a credit score?
A credit score is a numerical measure of how you’ve handled debt in the past. It gives lenders an estimate of how risky you are to lend to in the future.
Scores range from 350 (poor) to 850 (excellent) and are calculated by each of the three major credit reporting bureaus – Experian, TransUnion & Equifax.
Your credit score is impacted by:
- Payment history
- Total debt
- The percentage of available credit in use
- Length of credit accounts
- Collections, foreclosures, or bankruptcies
- Type of loan accounts
- New credit applications (called hard inquiries)
Why do you need to improve your credit score?
The biggest benefit of improving your credit score is spending less on loan interest. When you’re seeking a new loan to purchase a home or vehicle, a higher credit score will help you get a lower interest rate. A lower interest rate means you’ll spend less on interest over the length of the loan.
A good credit score is important even when you’re debt-free or don’t anticipate needing a loan soon. Your credit score matters when:
- Renting a home
- Setting up new utilities
- Working certain jobs
- Applying for property insurance (homeowners/renters or auto insurance) OR life insurance
How to improve your credit score
There is no quick fix for your credit score. To improve your credit score, you’ll have to be patient and strategic. Be wary of any company that offers to “fix” your credit for a fee.
There is also no specific formula for improving your credit score. Each of the three credit bureaus has a slightly different method for calculating credit scores, which they don’t readily share. That means no one can say “pay off $4000 and your score will increase by 50 points” and back it up 100%.
1. Review your credit history
The very first step to improving your credit score is to review your credit report. Your credit report will not show your score, but it will show all the outstanding debts under your social security number.
Look over the report carefully, making sure to note any errors. Sometimes, debt is sent to collections without proper notification or attributed to the wrong person. You can write to the reporting bureau to request corrections.
You can request a free credit report from each of the 3 bureaus annually, per federal law. During the COVID-19 pandemic, you can/could get free reports weekly. Make sure to look for that option if you find issues with your report; more frequent reporting will help you monitor the situation.
During more normal times, you should request a credit report every 4 months. Rotate through the 3 bureaus and you’ll have pretty regular access to your credit history.
2. Establish credit, if you need to
While you can get a mortgage with no credit score, it’s not the most straightforward or practical route. The easiest way to establish a credit score is to open a credit card and PAY IT OFF IN FULL EVERY MONTH.
A super simple way to do this, without risking mountains of debt, is to pay for a monthly subscription, like Netflix, with that credit card. Automate the subscription payment and automate the payoff of the credit card.
Carefully using a credit card helps you:
- stay on budget
- never have a late payment
- not accrue debt
- establish credit history
- build a credit score
You obviously don’t want to carry a balance on the card, miss payments, or overspend, which is why I recommend this very controlled method for establishing credit. It will take time, but eventually, you’ll have a payment history and credit score.
Look for a credit card with no annual fee and rewards that you will actually use. I don’t have a Delta Airlines credit card, because we almost never fly & accumulating miles would be a waste. Instead, I use a card that offers cashback, which we use for special purchases.
Plan ahead when selecting a card as well- the length of your accounts affects your credit score, so it’s a good idea to keep this account open even after you’ve established your credit history. Don’t get a credit card through a small local bank when you know you’ll move out of state in the future and not have easy access to that bank.
3. Make payments on time
Payment history makes up 35% of your credit score. So, the easiest way to improve your credit score is to make payments on time, every month.
The scoring models look at:
- how late the payment was (30 days? 90 days?)
- how many late payments are made
- how long it’s been since a late payment was made.
One 30-day-late payment 3 years ago will have less impact on your credit score than many 90-day-late payments in the last year.
Failure to make multiple payments could result in that loan account being sent to collections. Collections obviously negatively affect your payment history, and therefore your credit score. They can be a pain to recover from; if you can make the minimum payments, try to do so and avoid collections.
Bankruptcies, repossessions, and foreclosures also negatively affect your credit score. They’re all results of missed payments & poor payment history. These issues have a larger (worse) impact on your score than a simple late payment.
Get current on past-due accounts
Making payments on a past-due or collection account won’t erase the late or missed payments in your past. Those payments will start the process of improving your payment history though.
If your account is past-due but not in collections yet, start making payments as soon as possible to avoid collections. A late account isn’t as harmful as a collections account.
It also looks better to pay off an account in collections rather than have it written off due to non-payment (and it’s less of a headache).
4. Reduce your credit utilization ratio
The amount owed makes up 30% of your credit score… but it’s not as simple as looking at total debt. Instead, credit bureaus factor in your credit utilization ratio.
The credit utilization ratio is a measure of how much available credit you’re using. It’s calculated by dividing outstanding debt by the total credit limit available. This metric focuses on revolving debt, like credit cards, more than installment loans, like a mortgage or student loan.
A lower credit utilization ratio is better because it means you’re using a smaller percentage of the debt you have available, indicating that you’re handling debt payments well and you’re likely to pay back new loans. . Maxing out credit cards brings down your credit score because that behavior increases your credit utilization ratio and makes you riskier from a lender perspective.
What is a good credit utilization ratio?
A single-digit utilization ratio is best for a good credit score, but a ratio of 0% isn’t ideal because it indicates you’re not using debt. Credit scores are a measure of your responsibility with debt, so a good credit score requires some debt.
30% seems to be the cutoff for a good credit score, but there’s no hard & fast rule. Paying off the debt & improving your ratio is more important than the specific number.
Remember that your ratio will fluctuate from month to month too unless you somehow manage to pay off every credit card balance every month before the reporting date. I know I’m not that organized, so we see rises & falls with the percentage of debt we’re using. That’s why aiming for under 10% is more realistic than focusing on 4% exactly.
Pay down revolving accounts
Revolving debt accounts are those that allow you to take out debt, pay some off, and take out more debt. The most common example is a credit card, but it could also be a home equity line of credit or personal loan.
Revolving debt is less desirable & riskier for the lender. The utilization ratio of such debt is a bigger factor than how much of your mortgage you’ve paid off.
Paying down revolving debt accounts is the best way to improve your credit utilization ratio. It moves you closer to debt freedom and reduces the monthly minimum payments you have to make, which is nice in an emergency.
Increase credit limits
A quick way to improve your ratio is to ask for higher limits on one or more credit cards. Carrying the same amount of debt with a larger amount available reduces your credit utilization ratio.
If you have $10,000 in credit card debt, increasing your overall credit limit from $10,000 to $20,000 would move your credit utilization ratio from 100% to 50%, for example.
I would only recommend this strategy if:
- Your ratio is just about 30% or just above 10% AND
- You’re seeking a loan very soon
Increasing your credit limit is really just a short-term boost to your credit score. It’s better, overall, to pay down debt to improve your ratio.
5. Keep old accounts open
Credit history length makes up 15% of your credit score. Having both older accounts and an older average account age is beneficial.
To improve your credit score today, you can’t time travel and open up accounts in the past. I would focus on improving your payment history and credit utilization ratio for long-term benefits.
A quick way to increase the length of your credit history is to be added to someone else’s credit account as an authorized user. To be most effective, the account should be:
- With no late payments, and
- With a low credit utilization.
This assumes you have a financially responsible person in your life who is willing to trust you and help you… and that you’re committed to improving your finances enough that you won’t hurt that person, intentionally or unintentionally.
6. Changing credit mix doesn’t improve your credit score very much
The diversity of your credit accounts makes up 10% of your credit score. Having a wider variety is better.
Someone with a mortgage and 2 credit cards would score better in this category than someone with just a mortgage.
I wouldn’t recommend opening unnecessary accounts to improve your credit mix unless you’re opening that first credit card to establish credit in the first place. Once you have a credit history though, it’s usually not beneficial to add new accounts just to improve your score.
7. Limit new account applications
New credit makes up 10% of your credit score. If all of your credit accounts are new, your score will suffer. If you have older accounts but just opened up 3 new credit cards, your score will suffer. Even applying for a new loan or credit account drops your score a little.
When you apply for a new loan, the lender or bank checks your credit report; this is called a hard inquiry. A single hard inquiry isn’t bad, but having many hard inquiries over a long period of time will decrease your credit score.
To minimize the impact of hard inquiries, only apply for new accounts when you really need them (don’t fill out credit card applications just because you were “preapproved”). They linger on your credit report for up to 24 months, although they may not affect your score for that long.
When seeking a new loan, it is definitely a good idea to shop around for the best rates and terms. That means you’ll probably have multiple hard inquiries, but their impact is limited if they’re all made around the same time.
How long does it take to improve your credit score?
Unfortunately, there is no easy answer to the question “how long does it take to improve your credit score?”
The time required for improvement depends on why your score was low in the first place, how “bad” it was, and how high you need to raise your score.
Paying down debt, if you have cash reserves, would be a quick way to increase your credit score by improving your debt utilization ratio. If you don’t have the savings and you’re living on a tight budget, it will obviously take longer.
If your payment history is the issue, time is the biggest factor. You can’t rush that.
Basically, you need to create a plan, follow it, and be patient to improve your credit score.