Your credit score affects more aspects of your life than you might think, from seeking out a loan to putting a down payment on a house and even the job hunt. Unless you’ve been diligently saving for as long as you can remember, came into an inheritance, or have a great-paying job, you’ll likely need to apply for a loan to make one of those large purchases. A low credit score, which can also prevent you from getting approved for credit cards. Read on for expert tips on improving your credit scores, including reading your annual credit report, how to protect against fraud, and how to pay off debt.
“When applying for these types of loans, lenders perform a credit check. This helps lenders decide if they want to do business with you, and on what terms,” says Jake Lunduski, a financial industry analyst at Credit Card Insider. “Generally, the better your credit, the better the interest rates you’ll be able to secure.” Credit scores fall between 300-850 and tell bankers and lenders how reliable or risky you are when it comes to repaying debt.
It’s possible you’ll still be approved for a loan if you have a lower score, but you may be required to put down a larger deposit or pay more interest. For example, someone with a score of 720 may have a 5% interest rate on a $500,000 30-year mortgage while someone with a score of 800 may have a 4.5% interest rate on the same mortgage. That .5% difference is like giving away $40,000-$50,000 to a mortgage bank, says Roxana McKinney, founder of Women Wealth & Worth.
“There are multiple scoring organizations that have different scoring systems. However, the type of score most commonly used by lenders is one of your FICO scores,” Lunduski says. While credit scores calculations may seem like a mystery, consumer credit scores tend to follow a few common principles, which makes improving your credit score a less daunting task. Read on for eight things you can do to improve your credit score in a year.
Check Your Credit Score
FICO scores are based on five different criteria: 35% payment history, 30% amounts owed, 15% length of credit history, 10% new credit, and 10% types of credit.
It’s very important to stay on top of your payment history and credit usage, since they make up 65% of your score. In addition to the one free credit report per year from each credit bureau at AnnualCreditReport.com, McKinney recommends checking your credit score once every three months on a free credit score site such as Credit Karma, which won’t hurt your score. Hard inquiries—when a potential lender is reviewing your credit—may pull your score down by 5-10 points. You can dispute a hard inquiry, but it will generally fall off your report in two years.
Look for Inaccuracies
When requesting your free annual credit report, make sure each major consumer credit bureau is checked, including Equifax, Experian, and TransUnion, in addition to free credit score sites. Once you receive your annual report, there are six things you should monitor, according to Lunduski:
- Is your personal information accurate and up to date?
- Do you recognize every account listed? Are all the dates and lenders names correct?
- Do all account balances listed match the balance on your most recent statement?
- Make sure any hard inquiries on your reports were made at your request.
- Are any late payments listed that don’t belong? If you have late payments, make sure they are classified correctly (30 days late, 60 days late, etc.).
- Check for any bankruptcies, tax liens, and collection accounts and make sure the details are correct.
Protect Against Fraud
Prevention is the best form of defense. Before you even suspect fraud, you can protect yourself by freezing your accounts, preventing others from stealing your information. Freezing your account locks your credit score, so no individual or company can access your credit information unless you unlock it. After reporting fraud to credit card companies, it takes time to repair credit score damaged by identity theft, so why not be one step ahead? Whether or not you suspect fraud, Daniel D’Ordine, CFP, founder of DDO Advisory Services LLC, recommends “LifeLock.com because it aggressively monitors for negative activity, especially when there are too many things to lose track of and data breaches. …There is less accuracy to keep track of in your report if you are managing it responsibly without too many accounts open.”
Pro tip: Check to see if your children have a credit score. If they do and you haven’t opened any accounts for them, that means they are victims of identity theft. This should be sorted out as soon as possible.
Watch Those Credit Card Balances
The smaller your credit utilization ratio (how much of your credit card limit you use month to month), the better for your score. So, to have an immediate impact, you want to pay your debt down, D’Ordine says.
Another way to lower your utilization is to increase your credit lines. “This way, you can spend the same amount or more without a negative ding, because your utilization amount is higher,” McKinney says. Remember: Just because you have a higher credit line, doesn’t mean you need to use more credit.
Pay Off Debt
If you find yourself stuck in debt across multiple credit accounts, Lunduski recommends the Avalanche Method, explained by his colleague Brendan Harkness. First, make the minimum payments on all of your accounts. Then, put as much extra money as possible toward the account with the highest interest rate. Once that debt is paid off, start paying as much as you can on the account with the next highest interest rate. Use this method until all of your debt is paid off.
“After any debts are paid off, ensure that you’re using your credit cards with discipline,” Lunduski adds. “Always make sure you’re paying off your statement balances on time and in full to take advantage of the grace period most cards have to avoid expensive interest.”
Pause Before Closing Card Accounts
Many people believe closing a credit card is better for credit scores, but, in fact, it can have the opposite effect. “Young people who opened their first card in college will move to others for points or miles, and will close their first card,” McKinney says. “This will bring down your total available credit and average account age.” So, keep your starter credit card from college in addition to newer cards with better benefits because it will boost two categories of your FICO criteria. As long as a card is paid off and has no annual fee, it can continue to help your credit scores. Instead of closing the account, try to lock it.
Consider Opening New Card Accounts
“Another misconception is opening a credit card hurts your credit scores. Although your credit scores may temporarily dip after applying for a new card, you won’t face any long-term negative effects unless you max your new card out and accumulate debt or don't pay on time,” Lunduski says. Opening a new card raises your total overall credit limit and can help lower your credit utilization ratio. You'll take a hit in average account age in the short term, but more cards can help you in the long term.
While a new credit line increases your overall limit, D’Ordine warns against opening a handful of credit cards willy-nilly. “It’s not worth that one-time, 20-percent discount to go open a credit card with a store every time you purchase something from there. You’ll lose track of stuff, it’s easy to let these things creep up. The interest rates are usually unfavorable, and it’s bad news,” D’Ordine says. Instead, research what credit card is best for you, whether you want to earn airline miles, cash back, or points for other benefits, and try to choose one with a lower interest rate.
Don’t Let Past Mistakes Haunt You
“Because too many cards can become unmanageable, get them all paid in one day,” McKinney advises. You can ensure your bills are being paid on time by changing the payment dates, turning on online-billing Auto-Pay, which automatically takes money out of your bank account, or paying as soon as you get a statement in the mail.
Above all, “let your life events drive your financial decisions,” D’Ordine recommends. As much as you may want to live within your means, plan, and budget financial decisions, life happens. If your finances or credit need rebuilding, or it all seems a little too daunting to do on your own, don’t be afraid to seek out a certified financial planner.
