How To Improve Your Credit Score
/Your credit score plays a big role in determining the interest rate you will pay for a credit card, mortgage, or any other line of credit or whether you will get a loan at all.
Your credit score is reviewed when looking to get credit or negotiate for lower rates on your open credit accounts, as lenders use it to help them determine your creditworthiness. They also review it for when you are approved for any line of credit to determine the interest rates you may get on that loan.
Photo by Mathews Luz from Pexels
The higher your credit score, the less risky you are seen by lenders, which means you are more likely to be approved for credit when you apply for a credit card online, mortgage, personal loan, or any other type of credit product, or get a competitive interest rate when you are offered a loan. It can also help you qualify for a lower rate on an existing credit account
On the other hand, the lower your credit score, the riskier you are seen by lenders, and the less likely you are to be approved for a credit product. Even if you are approved for a line of credit, you can be charged a higher APR.
If you have a lower credit score and are wondering how to improve it, first it is important to understand what is a credit score and how it is calculated and then take steps to raise it.
What is a credit score?
A credit score is usually a three-digit number, generally between 300 and 850, that lenders use to assess a borrower's potential creditworthiness.
Your score is generated by a variety of scoring methods such as FICO and VantageScore by using the information in your credit history. Your score can vary by a few points, depending on which scoring method is used to calculate it.
Your credit history is a record of how you use credit. It tells lenders when you have applied for credit, your existing credit accounts, your payment history, and available balances.
If you have never used credit in the past, you may not have a credit history or score at all. If someone has low credit score, they will likely have negative marks on their credit reports that lead to a poor credit history and credit score.
Lenders use your credit score to predict how likely you are to pay back in the future if you are offered a line of credit. Your score tells lenders how well you have managed credit in the past and lets them predict how likely you are to pay back a line of credit in the future.
Your current lenders may use it to assess whether to lend you more credit, and/or whether to lower or increase your current interest rates on their current credit products that you are using.
How a credit score is calculated
If you want to improve your credit score, you must first understand how it is calculated. There are different credit scoring models used to calculate an individual's credit score. They all take similar factors into consideration when calculating an individual's credit score.
These are the factors used by credit scoring models to calculate your credit score:
Your payment history
Your credit utilization or, in others words, your debt-to-credit limit ratio
Length of your credit history
Credit mix, i.e. type of credit that you have taken out
Open credit applications
Certain factors such as your payment history and your credit utilization ratio have the biggest impact on your scores than other factors. If you have got a less than stellar credit score, it is important for you to understand how these credit factors influence your credit score.
How to improve your credit score
First, it is important for you to understand how the credit factors influence your credit score. Then you can take steps to improve your score.
It is possible to improve your credit score in as little as 1-2 months or a few months, depending on how well you handle your credit in the meantime and the most recent information held on your credit reports.
But if you have lots of negative information on your credit reports, it may take longer to improve your score. Depending on the issues you are trying to overcome, you may first need to rebuild your credit and then improve your score.
If you have a less than stellar credit score, here are the things you should do if you are wondering how to improve your credit score:
Pay your bills on time and every time
Your payment history is hugely influential to determine your credit score. You can have a lower credit score if you missed a payment or made a late payment in the recent past. A missed payment or late payment can quickly drag your score down. A series of missed payments can lower your score significantly.
But the good news is even if you have negative items like a recent missed payment or a late payment on your credit report, your credit score can bounce back in 3-6 months by paying all your credit card payments, loan payments, and other bills on time every time during this period.
Missed payments or late payments stay on your report for seven years. But if you continue to pay your bills on time after a missed or late payment, your score will bounce back in a couple of months or so and improve. But if you defaulted on a series of payments, it will take longer to rebuild and improve your credit.
Keep your credit utilization ratio low
One of the best ways to increase your credit score is to reduce your balances on all of your credit accounts. Your credit utilization ratio is how much of your total credit limits across all your credit accounts you are using.
For example, if you have a total limit of $5,000 across all of your credit accounts, and you use $2,000 of that each month, your credit utilization ratio is 40%.
A low utilization ratio will be seen positively by lenders, and will increase your credit score as a result. The lower the percentage, the higher your score will be. If you have a higher utilization ratio, reduce your outstanding balances, and keep your utilization ratio at or below 30%.
You can reduce your balances or increase your credit limit to lower your utilization ratios. Another option to lower your balances is to get a new line of credit, but you should only consider this option if you can handle extra credit with discipline.
Only apply for and open new credit accounts if needed
Just because a better credit mix is good for your credit score, do not apply for unnecessary credit because you could end up hurting your credit score if you cannot pay back any extra money you borrow.
Each time you apply for a credit card, loan, or mortgage, a hard inquiry is created in your credit reports. Having too many hard inquiries on your credit reports can negatively impact your credit score, as lenders may think you are desperate for credit.
So do not apply for new credit unless you need it, as too many credit applications will decrease your credit score. Besides, if you open too many credit accounts, you may be tempted to overspend and accumulate debt over time.
Use different types of credit
Your credit score will go up if you have a mix of credit products such as a credit card, store card, personal loan, and mortgage. So if you only have one type of credit product, it is better to have different types of credit, but make sure you can pay back any money you borrow.
If you have different types of credit, but cannot use that credit with discipline, then your score will be lowered.
Do not close unused credit accounts
Keeping unused credit cards open as long as they are not costing you money in annual fees can improve your credit score, as keeping unused credit accounts open increases the length of your credit history. So the longer the age of your credit accounts, the better it is for your score.
Keeping unused accounts also helps keep your credit utilization ratio low. Closing an unused account may increase your credit utilization ratio which could hurt your score, particularly if you already have a high utilization ratio.
Do not apply for credit unless necessary
Do not apply for too much credit as too many applications for credit will drag your scores drastically.
While opening a new credit account can increase your credit limit and decrease your credit utilization ratio which can improve your score over time, every time you apply for new credit, it creates a hard inquiry on your credit report.
Every time a lender asks for your credit report, it is recorded as a hard inquiry or credit check. A hard inquiry can temporarily lower your credit score by a few points. Too many hard inquiries can lower your credit score significantly. So limit your number of applications for new credit.
If you already have an established credit history, then applying for and getting a new type of credit can improve your score.
Apply for a credit builder credit card
If you have never used credit or have poor credit because there is negative information on your credit reports, you are less likely to be approved for a credit card or loan. But there are other ways to build or rebuild your credit and improve your credit score.
Getting a credit builder credit card is one of the best ways to build your credit from scratch or rebuild your credit and raise your score over time if you use this card with discipline by paying your bills in full on time each month.
Another way to build credit and improve your score when you have no credit or thin credit is to ask a relative or friend who has a higher credit score to add you as an authorized user on their credit card. As long as they make their payments on time every time, your credit score will improve.
Check your credit report for errors
Correcting errors on your credit reports is a quick way to improve your credit score. The first step to checking your credit report for errors is to get a copy of your free credit reports once a year from the major credit rating companies: Equifax, Experian, and TransUnion.
Next, check your reports for errors and correct any errors that occur on one or more of your credit reports. Common errors to look for include accounts showing up that are not yours, closed accounts reported as open, or inaccuracies related to overdue and delinquent payments.
Typically, it takes one to two months to correct an identity error.
Your credit score will improve when errors on your credit reports are corrected. Check your credit reports from the three major credit reporting companies at least once a year for errors.
In conclusion
As you have seen, if you are wondering how to improve your credit score, the best way to improve it is to use your credit cards and loans with discipline by making on-time payments every month, keeping a low utilization ratio,
By improving your credit score, you can appear as a less risky borrower to your potential lenders who will be more likely to offer you credit at a competitive rate.
Disclaimer: the content presented in this article is for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.
