There are many articles and blogs that go into great depth about credit scores. With that in mind let’s see if we can take a quick look at credit scores and provide some basic understanding. Each person who utilizes credit, from credit cards to auto loans, has three standard credit scores, as a person’s creditworthiness is tallied separately by the three major credit reporting agencies. The scores – known as FICO scores, for Fair Isaac Corporation, the company that developed and pioneered credit scoring about 50 years ago, range from 300 to 850. The most current national average suggests that the national median score is about 683.
So what does one do if they want to improve their credit score? There is no doubt that the effort to raise your score is a very difficult one. Fortunately, there are a number of reputable companies out there to help you if you choose. What you need is to find the right solution for you as every situation is different. If you work with an outside company, you need to make sure that your consultant will provide a private and confidential review of your current financial situation. Their intent should be to learn about your situation, in order to best identify how they can work with you to improve your credit. These days, credit is important for securing your next mortgage, auto loan or credit card. We also know that some employers are running credit checks for new employment opportunities and simple consumer accounts must have a background credit check. This is why it is so important to take control of your personal credit score.
Improving Your Credit Scores
Improving your credit is not only worthwhile, it a smart thing to do. A common misconception is that getting more credit means that you are more credit worthy. That is completely incorrect because that’s not what happens. For example, throughout the year, many retailers and credit card companies often offer you the chance to save 10-20% or more on purchases by opening a credit card account. If you are also looking to purchase a house or buy a car during that time, you might want to stop and think twice about signing up.
Why? Because by opening several credit lines in quick succession can actually lower your credit score. This score is used by every company or business that provides credit from car dealerships to mortgage lenders and they calculate just how likely you are to repay your debts. You need to know that lower scores mean you may be charged higher interest rates on auto loans and other types of borrowing. They can also affect you in less obvious ways. Many auto insurers, for example, use credit scores to set premium prices, and a growing number of employers factor them into their hiring decisions as we mentioned before.
While the calculations and methodology behind FICO scores is extremely complex, there are a few key principles that you can follow to raise your credit score.
1. Basically the most important way to improve credit scores is also the least complicated. Pay your bills in full and on time. Your overall history of making payment on your current bills accounts for about 35% of the FICO score. Missing credit card payments or submitting the minimum due each month will immediately lower scores, as will any debt collections or bankruptcy filings that show up on your credit report. The only good news here is that credit scores reflect your most recent activity, so major negatives like collections will eventually mean less and less, even if it take years to work their way off your credit report.
2. Maxing or topping out your credit cards will drop your score like a rock. Even using 50% or more of your limit can cause problems because it increases the risk that you may not be able to repay. For anyone looking to boost their score the key is to maintain a low “credit utilization” level. This refers to the percentage of available credit that you have on each of your credit cards. The credit utilization level falls under a complex category known as “amounts owed.” This makes up 30% of the FICO score. If you have five credit cards with a $5,000 credit line each, for example, it’s not wise to carry a balance of more than $2,000 per card. It’s better to carry smaller balances on several cards than to pile everything onto one card.
3. Build up an active and lengthy credit history. This means it’s usually better not to close out all of those old credit cards – unless new ones are replacing them – because keeping them open builds your credit history. This makes up about 15% of the FICO score. Keep a few dormant accounts active. This will help lower the balance to limit percentage since limits are factored into the credit utilization formula.
4. Don’t open new accounts within 60 days of making a major purchase. This results in about 10% of your score. Taking out new credit lines raises red flags because it makes you look riskier. This is why it’s best to avoid all those retail cards during the holidays – unless of course, a temporary decline in your credit score is no big deal. Just be smart and think twice about your future purchases and what looks likely to take place over the next few months.
5. Have a wide variety of credit experiences and loans, over time. This is called diversification and means that you have had and get credit for having a variety of loans, so it’s better to have an assortment, including installment plans like auto loans or mortgages rather than simply credit cards.
6. Get a copy of your credit report and make sure your credit report is accurate. This is very important. Since credit scores are based on credit reports, it’s very important to make sure the information in your reports are fee of errors and fraud. Federal law gives you the right to get a free report from each of the major credit bureaus once per year.