improve your credit score

Complete Guide To Improve Your Credit Score

As I previously mentioned in an earlier article “Why Your Credit Score Doesn’t Matter“, I mentioned that the credit score is the most meaningless metric in personal finance. This article will be an in-depth guide to helping you improve your credit score though!

Your credit score is not impacted by your income/earning potential. Your credit score is only based on how you have handled debt in the past.

There is no forward looking aspect, but having a good credit score can prove to be incredibly beneficial.

Why You Want A Good Credit Score…

First and foremost, I will preface this article with the fact that your credit score is not the end-all-be-all. However, there are many positive reasons to strive for a high credit score.

According to The Balance, there are many positive benefits to having a good score.

Lower Interest Rates on Loans

Unless you have some ridiculous inheritance, have an incredibly well-paying job, or live in an extremely cheap town, it is more than likely that you will have to take out a mortgage when you buy a house.

I am not always pro home ownership, so check out my article “Don’t Buy a Home in Your 20’s” to see if you should buy or rent!

Regardless, if you have pulled the trigger and decided to buy a home, having a higher credit score will equate to a lower interest rate.

This is because you are viewed by lenders as “less risky”. Less risky means you have a lower statistical probability of defaulting on your outstanding loan, and the lender has a higher chance of being repaid.

A lower interest rate means a lower monthly mortgage payment and increased savings over time.

I am all for saving money, and there is a HUGE difference between a 4% interest rate and a 5% interest rate for a $300,000 mortgage.

A 1% lower interest rate on a 30-year fixed rate mortgage saves a home owner over $54,000. AND this is all from having a higher credit score!

Easier Approval For Renting

“More landlords are using credit scores to screen tenants. A bad credit score, especially if it’s caused by a previous eviction or outstanding rental balance, can severely damage your chances of getting into an apartment.

A good credit score saves you the time and hassle of finding a landlord that will approve renters with damaged credit.” 

Better Car Insurance Rates

Esurance states that “To establish eligibility for payment plans and to help determine insurance rates, most U.S. insurance companies, including Esurance, use credit-based insurance scores, along with your driving history, claims history, and many other factors.

If you have a high credit-based insurance score, an excellent driving history, and zero claims on your record, you’ll typically qualify for lower rates.

Of course, your score is only one of many factors used to calculate your premium. If you have an excellent insurance score but a less-than-stellar driving history, for example, you might be considered riskier to insure.

While the reasons why are less than crystal clear, research shows that credit scores can accurately predict accident potential.

Statistical analysis shows that those with higher credit scores tend to get into fewer accidents and cost insurance companies less than their lower-scoring counterparts.”

Credit Score Calculation

“Your Score is calculated using positive and negative information on your TransUnion credit report.

It summarizes your risk to lenders at a specific point in time. FICO Scores consider the following 5 categories of information.

The breakdown below illustrates the significance of these categories for the general population.

Note, however, that your individual score may give some factors more or less importance based on the information in your credit report.”

  • Payment History: 35%
  • Revolving Utilization: 30%
  • Length of Credit History: 15%
  • Credit Seeking Activity: 10%
  • Credit Mix: 10%
Improve your credit score

Payment History

Proving to creditors that you will consistently pay them back comprises 35% of your credit score. This is the largest factor to improve your credit score, and this makes sense for many reasons!

Your credit score is essentially a rating of how trustworthy you are as a borrower, and missing payments makes your more risky.

Creditors are not (or should not) loan money to people who have no chance of paying them back!

Set-up automatic bill pay to ensure you never miss a payment!

Revolving Utilization

Investopedia states, “The credit utilization ratio is the percentage of a borrower’s total available credit that is currently being utilized.

The credit utilization ratio is a component used by credit reporting agencies in calculating a borrower’s credit score. Lowering the credit utilization ratio can help a borrower to improve their credit score.

The credit utilization ratio is focused on a borrower’s revolving credit. It is a calculation that represents the total debt a borrower is utilizing in comparison to the total revolving credit that they have been approved for by credit issuers.

When managing credit balances a borrower should also know their current debt to income ratio, which takes into consideration both revolving and non-revolving credit and is another factor that is considered when submitting a credit application.

This is how a credit utilization ratio is calculated. Say a borrower has three credit cards with different revolving credit limits.

  • Card 1: Credit line $5,000, balance $1,000
  • Card 2: Credit line $10,000, balance $2,500

The total revolving credit across all three cards is $5,000 + $10,000 = $15,000. The total credit used is $1,000 + $2,500 = $3,500.

The credit utilization ratio is $3,500 divided by $15,000, or 23.3%.”

Length of Credit History

The “length of credit history” is how long any given account has been reported open. Generally, the longer an account has been open and active, the better it is for the credit score.

This is particularly true for an account with a positive payment history that has no delinquency.

The credit scoring algorithms calculate the average of how long all your accounts have been open. That average age of accounts is your “credit age.”

It’s all but impossible to get a score higher than 800 if you’re young. Your credit age likely will be less than that of a person who has had credit for years.

Credit Seeking Activity

There are two types of credit seeking activities from MyFico: hard inquiries and soft inquires. “As far as your FICO score is concerned, credit inquiries are classified as either “hard inquiries” or “soft inquiries”.

Only hard inquiries have an affect on your FICO score.

Soft inquiries are all credit inquiries where your credit is NOT being reviewed by a prospective lender.

These include inquiries where you’re checking your own credit (such as checking your score in Discover or Credit Karma), credit checks made by businesses to offer you goods or services (such as promotional offers by credit card companies), or inquiries made by businesses with whom you already have a credit account.

Hard inquiries are credit inquiries where a potential lender is reviewing your credit because you’ve applied for credit with them.

These include credit checks when you’ve applied for an auto loan, mortgage or credit card. Each of these types of credit checks count as a single credit inquiry.

One exception occurs when you are “rate shopping”. That’s a smart thing to do, and your FICO score considers all inquiries within a 45-day period.

This same guideline also applies to a search for a rental property, such as an apartment. These inquiries are usually recorded by the credit bureau as a type of real estate-related inquiry.

Credit Mix

Your credit mix is important for lenders because they like to see consistency across a variety of borrowing platforms.

Never missing a payment on a credit card does not automatically translate to a borrower paying their mortgage.

Credit mix is one of several factors that affect your credit score. Credit scoring company, FICO, assigns importance to your ability to balance different types of credit accounts, such as credit cards, a car loan, student loans and a mortgage.

However, credit mix is far less important for your score than paying all your bills on time and using less of your available credit limit.

Improve Your Credit Score With Credit Cards

I personally believe that the best way to initially improve your credit score is by opening a credit card. I opened my first credit card at the bright, young age of 18.

Then, one year later, I opened my second credit card through Discover. I have established three full years of credit history, and I have amassed a 793 credit score!

First, we must lay ground rules for credit cards because credit cards are like fire. Too much fire, and you will burn yourself.

Just enough fire, and you can grill meat and keep warm! Credit card companies will offer incredible bonuses to entice people to sign up for their card.

Americans are over $1 trillion in credit card debt! Follow these ground rules, and don’t be a sucker in credit card debt!

Rule 1: Don’t Spend Any Extra Money

First, NEVER EVER EVER spend any money you wouldn’t ordinarily spend on necessities. Necessities include gas, groceries, utilities (not vacations, online shopping, and reckless, irresponsible spending).

“The correct thinking is: I’m going to put my normal, every day spending on this credit card…then I’m going to get any rewards, for money I was going to be spending, anyway”.

Rule 2: Never Pay Any Credit Card Interest

For almost EVERY credit card out there worth getting, you are ONLY charged interest if you don’t pay off your balance off IN FULL by the time it’s due.

So ALL you need to do is NOT spend money you don’t already have, and then pay off your credit card in full…then you pay ZERO interest.

Conclusion

The best way to improve your credit score is to open a credit card, and only use it to purchase necessities.

This will help you increase your length of credit history and lower your revolving utilization. Buy necessities, pay them off, repeat, and in no time you will have an 800+ credit score.

Having a good credit score will lower your interest rate on loans, decrease car insurance premiums, and make it easier to get approved for rental properties.

The credit score is meaningless in nature, but it is incredibly important for saving money over time!

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