Understanding and Improving Your Credit Score
Your credit score has a huge impact on some of the biggest aspects of your adult life. You’ll likely need a decent score if you want to rent, lease or finance a car, open a credit card account, and of course, buy a home. Even potential employers can check your credit to screen applicants who may be a theft or fraud risk to their company. Your credit score is incredibly important, and neglecting to improve it can result in low scores that land you high interest rates and thus cost you more money. To avoid making costly mistakes that harm your credit, you first have to understand how it works. When lenders and credit issuers evaluate an application, they usually want both your credit report and credit score. The score is a mathematical calculation based on the information found on your credit report. The score represents how much of a credit risk you may be to lenders. You have probably heard your credit score referred to as your FICO score, because the software used to calculate them was developed by Fair, Isaac, and Company, or FICO. All the major credit reporting companies use FICO scores, but sometimes different sets of information on their reports. FICO scores range from 300 (the highest risk) to 850 (the lowest risk), and that score depends on many factors. The major factors are the following:
Bill payment history. If you consistently pay your bills on time, that will be reflected in a higher, less-risky score. But if you’ve been late in payments, had debt sent to collections, filed for bankruptcy, etc., that will factor into a lower, higher-risk score.
Your outstanding debt. This is your total debt, including mortgage, car loans, student loans, credit cards, home-equity lines of credit, and any other type of loan reported to a credit agency. And while it may seem like lower balances will always result in better scores, a very important factor is how much available credit you don’t use. Those who use credit sparingly — about 10% of what they have available, and no more than 30% — will have the highest credit scores.
How long you’ve had a credit history. The longer you have had and used credit (responsibly), the higher your score. Even better is if you have established long-term credit with the same set of lenders. College graduates will find themselves with a silver lining to all those student loans: they have been building a credit history, even if they’ve never touched a credit card.
Different types of credit. If you have a mix of fixed payment loans and revolving credit (like a credit card), you will have a higher score to reflect a variety of credit.
Hard credit pulls. If you have applied for credit several times in a short period of time, it will signal to lenders that you may a risky option. This risk results in a lowered FICO score. However, multiple applications for a specific type of credit in a short time frame (such as rate shopping for a mortgage lender) does not have the same negative effect.
Now that you know what your credit score is based on, it is easier to understand why those factors are important to lenders. Applicants with credit scores of 720 and higher receive the best deals when it comes to interest rates. If your score is below that, there are ways to improve it:
Review your credit report to stay updated and catch any mistakes. Your score is based on information on your credit report, so any errors on the report could be costly for you even if you actually have a good credit history. Get copies of your report from the three main reporting agencies (Experian, TransUnion, and Equifax) and check each for mistakes. You are entitled to one free report from each company every year.
Pay all bills on time. Check to see if your credit report shows any late notices. If you have an otherwise good credit rating, you might be able to get the lender to remove the notice.
Reduce your credit utilization rate. Your score is higher when your debt is lower as a percentage of your available credit. Pay down whatever you can and stop using credit for large purchases. If you cannot pay it down right away, ask your lender to increase your available credit. This way your outstanding debt will be a lower percentage of available credit…but you will need to resist the temptation to draw on any of that newly available credit. Make sure you never use more than 50% of available credit.
Keep credit card accounts open. This may seem counterintuitive, because once you’ve paid off a balance you probably want the satisfaction of closing it out. But when you close an account, you no longer have that available credit to count toward your utilization percentage. If you have more than five credit cards, close the newest ones so your long-term credit relationship stays in the report.
Consider installment loans if you only have revolving credit. Fixed-payment loans like a car loan or mortgage will increase the variety of credit in your report and you will be rewarded in your FICO score.
Avoid asking for more credit as much as possible. Inquiries about more debt will show up in your credit file like hard pulls and will lower your credit score.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.