What is a Credit Score?
Your credit score is essentially a summary of how well lenders think you can pay back a loan. Whether you are opening a revolving credit facility like a credit card, a fixed long-term loan like an auto loan, or a mortgage, lenders are always concerned about your ability to repay your debts.
If you are trying to improve your credit score because you want a new credit card or are attempting to improve your credit file in advance of a major purchase (like buying your first home), key ingredients are factoring into your credit score. By focusing on the factors that drive your credit score the most, you can improve your credit score to sweeten the benefits you receive from lenders and get a lower cost of credit.
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There are seven steps to improve your credit score:
1. Check Your Credit Score
Do you know what a credit score entails? A credit score is a rating from 300-850 assigned to consumers. Your credit score determines what types of credit you qualify for and the benefits you receive.
Your credit score is calculated by credit scoring companies based on information from your credit report. Each credit scoring company has a different way of calculating your credit score. Some credit scores are used by lenders for more general purposes, while others are for more specific purposes, like mortgages.
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Credit reports are created by three credit bureaus: Equifax, Experian, and TransUnion. These companies get consumer information from lenders based on your payment history. You can request your credit score annually for free, and some banks and lenders provide free monitoring services. It is a smart money move to patrol your credit score.
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2. Make On-Time Payments
The largest factor in determining your credit score is your ability to make on-time payments. This means paying your credit card balances on time. Lenders look very favorably on this factor because it predicts your ability to pay back new lines of credit.
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Missing credit card payments a few times may not seem like a big deal at the time, but this oversight can be costly in the long run. Even several missed payments early in your credit career can take months of diligence to recover from. Allocating at least six months of on-time payments to see a boost in your credit score is a smart money move.
3. Pay Off Debt
Your total outstanding debt affects your credit utilization. Lenders examine all types of credit accounts you have, including credit cards, auto loans, mortgages, student loans, and other consumer debt. The total credit you have outstanding is important to lenders because if you have too much debt lenders may perceive your ability to pay back a loan as a higher risk.
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Paying off debt is a quick way to decrease your debt burden, and simultaneously improve metrics lenders examine, like credit utilization. You may even try to become completely debt-free. Being debt-free will help your credit score because you will have no outstanding debt and have a credit history of paying off your debts. Future lenders will treat this favorably.
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4. Always Pay More Than the Minimum
You have heard this before. Doing the minimum won’t get you where you want to go. The same applies to your debt payments. Making on-time payments is essential to increasing your credit score, but so is paying more than your minimum balance payment.
Paying more than the minimum will decrease your outstanding principal balance which will ultimately increase your credit utilization and thus your credit score. Compounding interest works both ways. Only paying your minimum balance will increase your interest payments over time. By paying off your debts, you can accrue positive financial momentum, create smart money habits, and increase your net worth.
5. Increase Your Credit Limit
If you can increase your credit limit while keeping your debt balance constant, this can dramatically improve your credit utilization. As one of the highest contributing factors to your credit score rating, decreasing credit utilization is imperative.
How do you practically increase your credit limit? Simply asking your credit card company to raise your credit limit can be the fastest way. Plan this ask strategically. If you have made consistent on-time payments or increased your income recently, these factors make it easy for lenders to increase your credit limit.
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This is a high-impact task. You will see your credit score increase quickly if lenders agree to expand your credit limit. Increasing your credit limit can be done in only a few business days. The trick, of course, is to not increase your spending when your credit limit increases. If you can avoid lifestyle creep, your credit score should increase promptly.
6. Open New Credit Rationally
Building your credit should be done rationally. Opening numerous credit accounts all at once is not helpful to your credit. Lenders look negatively at this.
Instead, focus on securing new credit from one account at a time. Shop for the best credit cards or auto loans and choose only the best available to you. Once you have done your homework and opened only the best accounts, diversifying the types of debt in your credit mix can improve your credit score.
7. Diversify Your Credit Mix
Lenders want to know that you will pay back all types of credit. For those looking to establish a good credit history, adding different varieties of debt can help your credit file. Diversifying your credit mix could involve opening a new credit card, securing a personal loan, auto loan, or another consumer loan that reports to all three credit bureaus.
Frequently Asked Questions
A credit score is a number between 300-850 assigned to consumers to help lenders assess their creditworthiness.
If you want to increase your credit score, action is pivotal. Lenders typically report your payment history to credit reporting companies every 30 days. Focus on the most critical factors in your credit score.
The two most important factors in determining your credit score are paying your bills on time and your credit utilization. Quickly paying off your debts will increase your credit score.
A credit reporting company summarizes critical information about your credit history. The credit reporting companies, called credit bureaus, are Equifax, Experian, and TransUnion.
A credit-scoring company calculates your credit score based on the information in your credit report. The two most prominent credit score companies are FICO and Vantage Score. They offer different scores to lenders to help them assess your ability to repay certain types of loans.
