Here’s a look at how credit scores work, how they’re calculated, and ten steps you can take to start improving your score today.
According to the Fair Isaac Corporation (FICO), there are 5 factors that make up your credit score. They’re each weighted somewhat differently in terms of their effect on your total score. Let’s go through these one by one and describe specific actions to help you improve your score in each area.
Payment History (35% of Total Score)
Your history of making payments (or not, as the case may be) on loans and credit cards plays a big role in determining your credit score. Almost any type of late payment can affect your score. Cell phone bills, child support payments, medical bills… if you pay any of these late your score could pay the price.
Here are action items to consider to improve your score:
1. Pay on time. Credit cards. Utility bills. Library dues. Parking tickets. No matter what it is, pay it on time. If there’s ever a time when you can’t pay a bill on time (or you forget), do the following:
2. If you ever get a phone call or a letter from a collections agency, respond immediately and — it’s impossible to emphasize this enough — attempt to negotiate a removal of the collection from your credit file on the condition that you pay.
3. If you can only pay off certain past due amounts, be strategic about which ones to pay off first. Focus on the ones you can fully pay (so they won’t damage your credit score any more than they already have). Also focus on paying off the ones that have been overdue for the longest time.
4. Open and then close a credit account (but only if you do not plan on taking out a loan in the next year). One of the best ways to do this is when you’re making purchases at a department store and the clerk mentions a special discount if you apply for their credit card. Later that day, close the account. Pay the first bill as soon as it arrives. You’ve now added another “on-time account” to your credit report.
Amounts Owed (30% of Total Score)
Many people don’t realize that what matters most here is not the total amount you owe but the proportion of your available credit that you are using. For example, a balance of $5,000 on a credit card with a $20,000 credit limit (25% used) is better than a balance of $1,500 on a card with a $3,000 limit (50% used).
Actions you can take:
5. Don’t take on loans or expenses that you can’t afford. And as much as possible, reduce the revolving amount on your credit cards. If you need help with this, use one of the available online tools for eradicating credit card debt.
6. Only for the very disciplined: Call your credit card company and ask them to increase your credit limit, or apply for another credit card. Increasing your total credit limit will decrease the proportion that you’re using.
Length of Credit History (15% of Total Score)
This is pretty straightforward. The longer your credit history, the better. Here are actions you can take to lengthen your history:
7. Start developing a credit history as soon as you’re responsible enough to do so. Many people get their first credit card while in high school. As long as you start off with a very low credit limit to prevent yourself from making any rash or foolish spending choices, this can be a good way to kick off your credit history.
8. Don’t close an account in good standing unless you have to. It turns out, that credit card you’ve had for 10 years might be your credit score’s best friend (if you’ve used it wisely). Why? Because it’s the most tangible proof that you’ve consistently paid on time. Once the account has been closed, you won’t benefit as much from it.
Types of Credit (10% of Total Score)
There are many types of credit — auto loans, mortgages, credit cards, retail accounts, etc. — and having several different types can sometimes help your credit.
Actions you can take:
9. Check your credit report for free once a year via AnnualCreditReport.com. That site was mandated by the government to allow people to access their report. When you see your report, look over it carefully to make sure there are no errors on it. Occasionally, your credit can get dinged based on false or inaccurate information. By checking over the report yourself, you can make sure that doesn’t happen.
10. Beware of signing up for services that promise to monitor your credit report on a monthly basis — usually for a fee of up to $15 or $20 per month. These are usually no more effective than simply checking the report yourself for free once a year or even paying a one-time fee to see your report and score when necessary.