A good credit score is critical in your financial life. If you have poor credit, here are five ways to improve your credit score.
Why is a good credit score important?
You need good credit. It’s important to start building your credit score when you’re young to take advantage of savings throughout your career and life.
Your credit score plays a role in:
- getting the best rates on loans
- getting approved for a mortgage
- job applications
- getting approved for car loans
- lowering your insurance rates
- being approved for an apartment application
What if I pay cash for everything?
Even if your one of those rare people that pays cash for everything – food, eating out, new cars, even buying a new home in cash – your credit score is still important in your life and saving you money.
A low or no credit score is going to limit your options for home insurance and getting the best insurance rates.
Some employers will check your credit as part of your job application process. You may not ever get the opportunity to explain to the HR person (or the computer filtering resumes) why you’re credit score is what it is.
1. Pay your bills on time
Paying your bills on time is the single most important factor in your credit score.
If you missed the payments on all your bills this month, subtract between 75 – 125 points off your credit score.
Tip for paying your bills on time
Automate your payments – Set up your bills to auto draft from your checking account or credit card. Cell phone bills, utilities, Internet, TV, home/car/life/disability insurance can usually all be set to be charged to your credit card or withdrawn from your checking account.
Get your bills in the mail – As much as I try to do my part to conserve the environment, I do not like paperless billing. I get at least 50 emails a day and it’s easy to miss an email reminder to pay a bill.
Unless you pay a bill immediately as it arrives in your email inbox or have a good reminder system to keep track of those email bills as they arrive, a stack of bills is an easy way to visibly see that there are bills to pay. Make sure you pick a system that works best for you.
2. Keeping a low credit utilization rate
The amount of your available credit you have used, accounts for 30% of your score. First let’s define what that means with an example.
If you max out your credit cards you can expect a drop between 20 – 70 points off your credit score.
Example 1
Joan has a Visa, MasterCard, and Macys card.
| Card | Credit Limit | Balance |
|---|---|---|
| Visa | $10,000 | $3,000 |
| MasterCard | $10,000 | $3,000 |
| Macy’s | $1,000 | $1,000 |
Total available credit: $21,000
The total balance: $7,000
The credit utilization is $7,000 / $21,000 or 30%. You want to keep your credit utilization rate to 30% or lower.
Example 2: Over utilized
Now let’s say Joan has maxed out all of her cards:
| Card | Credit Limit | Balance |
|---|---|---|
| Visa | $10,000 | $10,000 |
| MasterCard | $10,000 | $10,000 |
| Macy’s | $1,000 | $1,000 |
Total available credit: $21,000
The total balance: $21,000
Her credit utilization is 100% because she has used all of her available credit.
Keep in mind even if Joan pays off her balance in full every month, anyone looking at her credit file would see she has used 100% of her credit until the balance has been paid off.
Example 3: Over utilized
What happens if the credit card issuer decides to lower Joan’s credit limit?
During 2008–2009 many card issuers lowered people’s credit limits to reduce the issuers liability. Let’s pretend Visa and MasterCard don’t want to run the risk of Joan spending too much money because the economy is tanking. They both decide to reduce the limits on her cards from $10,000 to $5,000.
| Card | Credit Limit | Balance |
|---|---|---|
| Visa | $5,000 | $3,000 |
| MasterCard | $5,000 | $3,000 |
| Macy’s | $1,000 | $1,000 |
Total available credit: $11,000
The total balance: $7,000
The credit utilization is now $7,000 / $11,000 or 63%. Joan is now over the 30% preferred rate simply by the credit card issuers whacking her credit limits, which they can do at any time for any reason.
3. Keeping open lines of credit
If you cancel some or all of your cards you reduce your available credit which impacts your credit utilization rate (See #2).
My wife and I have one credit card which we pay off each month and both of our credit scores are around 800. We have a high credit limit and rarely use more than 50% of our balance in any given month.
Preferably you want no more than 4–6 cards. If you have some cards you rarely use consider closing them.
4. Types of credit
If you have a bunch of store credit cards (Sears, Macy’s, Gap, Nordstrom, etc.) your score will not be as high as if you had only higher regarded cards such as Visa, Discover, MasterCard, Amex, etc.
To raise your score consider closing the store cards.
The Target Card is a higher value store card. Because Target gives 5% back on your purchases it’s worth keeping a Target card in your mix if you pay it off each month.
5. Credit age
A credit card or loan taken out in the last 30 days will have a negative impact on your credit score. The longer the account has been open the greater the benefit is to your credit score.
If you are applying for new credit, your credit score will temporarily drop around 10 points. That’s why when you are applying for a mortgage it’s a good idea to wait until after the closing before getting a new car loan.
Your score will slowly come up over time as the account ages and you pay your bills on time.
Now that you know what goes into making up your credit score, you can be on your way to improving yours.
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