Credit Health

How to Improve Your Credit Score

When you apply for almost any kind of loan, one of the facts that lenders will use to make a decision is your credit score, also known as a FICO score.  The lender obtains this three-digit number (it ranges from 300 to 850) from one of the three major credit bureaus (Trans Union, Equifax or Experian).  Calculated by a formula developed by a company called Fair, Isaac & Co. (hence the name FICO), this score represents to a lender your credit worthiness.  It not only influences whether your loan is approved, but it also influences your interest rate and other loan terms. The higher your credit score, the better loan terms you will get.  How do you obtain a good score?  Simply put, by paying your bills on time, using your credit sparingly, and watching for errors on your credit report.  Since nobody is perfect, our credit scores aren't always perfect either.  But whether you already have a great score, or a not-so-great one, there are things you can do to make it better.

Payment History

The most important factor that impacts your credit score is, you guessed it, your payment history.  Interesting thing is that, while a late payment is always a minus, a single late payment impacts people with good credit a lot more than people with bad credit.  The idea here seems to be that people with a problematic credit history

are almost expected to miss a payment here and there, while people with high credit scores are expected to be perfect. If there are late payments on your record there are a couple of ways to get them removed.  First, if it's an error, ask your creditor to correct it.  If it's not an error, it's only one or two late payments, and you are otherwise a good customer, write to the creditor and ask for a goodwill adjustment.  This does not always work, but if you've been their customer for a long time they may agree to simply erase the minus(es) from your credit file. (By "they" I mean the creditor, not the credit bureau.)  If they say no, continue to make payments on time, and after about twelve months the old late payments will start to carry less weight.

Limits vs. Balances

How much you owe on your current revolving accounts (credit cards) is almost as important to your credit score as your payment history (see graph).  What the FICO formula takes into consideration is the difference between your total available credit and your account balances.  The closer you are to your credit limits, the more risky a borrower you appear to the credit formula, and consequently your score will be lower.  By reducing your balances to below 30% of your total limit you should see an increase in your credit score. People who are actively trying to reduce their debt make one common snafu—in order to not be tempted to use available credit they ask their creditors to reduce their credit limits.  While this may be a good strategy to control your spending, it does not help your score one bit. It actually accomplishes the opposite.  Let's suppose your total credit limit was $10,000, and your credit card balances were $3,000, or 30% of the total limit.  You ask you creditor to lower your limit to $4,000, and now your $3,000 balance represents 75% of your available credit.  To the credit formula this looks like you are close to maxing out, which may mean that you are in financial trouble, so your score goes down. A similar scenario occurs when you close an unused credit card.  One credit card less means a lower total credit limit, so again, your score may get dinged.  This does not mean that people should never cut up credit cards—the fewer credit cards, the better, if you ask me—but don't do it before applying for an important loan (like a mortgage, or a car loan).

Length of Credit History

The third most important factor that determines your credit score is the length of your credit history.  This does not mean how long you've had a social security number, but how old your oldest open account is. Here is another drawback of canceling unused credit cards: if you cancel the ones you've had for a long time, and keep only newer ones, you will appear to be a much newer borrower.  So if you do decide to get rid of some credit cards, keep the oldest ones. Old credit is good credit, but only if you still use it.  If you have an old card with a zero balance that you don't have much usefor any more, do make an occasional purchase with it.  You don't have to carry a balance on it (you can pay off the charges as soon as you make them), but by using it at least every couple of months it will be reported on your credit report and help your score.

The strategies discussed above will help you improve your score, but the best formula for having a good score in the first place is still this: make payments on time, keep your balances low and check your credit report for errors periodically.


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