If you’re looking at buying a home, you’ve probably heard the phrase credit score come up over and over again. Your credit score is a critical factor in determining if you are qualified to get a home loan, among other essential purchases in your life.
Having a bad credit score will make qualifying for a loan much harder. From credit cards with reasonable rates to traditional and non-traditional loans, improving your credit score should be a top priority.
What is a credit score?
A credit score is a score created by the Fair Isaac Corporation and is commonly referred to as your FICO score. Your FICO score is monitored and reported on by the three main credit bureaus, Experian, Transunion, and Equifax. It’s a number on a scale from 300 – 850, and the higher on the scale your credit score is, the better. According to Equifax, one of the main credit bureaus, here is the generally accepted ranged of credit scores:
Poor: 300 – 579
Fair: 580 – 669
Good: 670 -739
Very Good: 740 -799
Excellent: 800 – 850
Your FICO score is looked at by creditors and lenders to determine your creditworthiness. If you have a higher credit score, you have demonstrated that you are responsible for your money and can both carry and pay off debt. This makes you an ideal candidate for a loan or a credit card, as you’ve been able to demonstrate that you will be able to pay the debt you’ve accrued back to your lenders.
How is your credit score calculated?
Your credit score takes into account many factors:
Payment history. Your payment history shows how many payments you’ve made on your accounts. It’s essential to show that you’ve made your payments on time, as late payments will decrease your credit score.
Credit Utilization. Credit utilization refers to how much of your available credit is being used. After your payment history, it’s the next most crucial thing measured. While paying your credit cards in full is always the ideal plan, it’s not always possible. With this in mind, try to keep your credit utilization under 30%.
If your utilization number is above 30%, that’s ok. It just means you want to focus the majority of your energy on paying down your debt.
Number of open accounts. Having too many open accounts can negatively affect your credit score, but so can having too few. Ideally, the open accounts you do have are active and have an excellent payment history. Your regular checking account doesn’t have much to do with your credit score, so if you only have a checking and savings account, you don’t have a credit score.
To start your credit score (and improve it!), open a credit card account that you pay off regularly. By paying off your purchases through a credit card, you’re showing that you have the ability to both carry and pay down debt.
While some studies show that three open credit accounts is an ideal number, what really matters is what you can afford. It can be tempting to open new credit cards and start making purchases right away. However, it’s best to use your credit cards to buy things that you know you’ll be able to pay off in just a few payments, if not right away.
If you have an old credit account that you don’t use, closing it doesn’t affect your score as old accounts and the length of your credit history go into determining your credit health.
Length of your credit history. If you’re new to having a credit card, you’ll find that you won’t be getting the best offers like high limits at low rates, but you’ll find that making purchases and paying them off regularly will start to make you eligible for good deals.
If you have purchases you always make, like gas or groceries, it may be a good idea to use a credit card for them as you know you’ll be able to pay it off every month. Another strategy is getting a card and making a more significant purchase, like a new computer or expensive gaming system. Again, making a big purchase and paying it off over time will help improve your credit score.
The longer your credit history, the better, as long as that history includes on-time payments and demonstrates you can carry debt and pay it off.
How to improve your credit score
Make it a habit to review your credit report. You can pull your credit score for free without penalty once a year. It’s important to keep track of your credit report to know what lenders see about you when they inquire about your credit. It lists things like bankruptcies, payment history, personal, identifying information, and the number of open accounts.
It’s important to check on your credit report as you may find inconsistencies or incorrect information on it that are dragging your score down. If you see something on your report that is incorrect, you can dispute it and get it removed from your report, so you have a more accurate idea of your credit score.
Set up auto-pay for your recurring bills. Most banks will allow you to set up auto-pay for your bills. Go into your credit accounts and see what your monthly payments should be. If you can afford to pay more than the minimum payment, do that, but the minimum payment is fine! You can set up automatic payments that go directly from your bank to your credit card company.
Only set up auto-pay if you have a steady income and know the money will be there. Otherwise, be sure to get paper bills to help remind you and set up calendar reminders to alert you when a payment is due.
Pay non-recurring bills as soon as you can. Sometimes you get bills for things that aren’t recurring, like doctor’s bills. It’s important to pay these bills as soon as possible.
30% Credit Utilization or less. As mentioned earlier, credit utilization refers to how much of your available balance you’re using. So, if you have $15,000 in credit and you’re using $7,500 of it, your credit utilization would be 50%.
While your credit utilization may fluctuate up and down, it’s essential to make sure your payments are all on time and that you’re carrying your debt responsibly.
Limit hard inquiries. A hard inquiry is when a creditor or a lender accesses your credit report because you’ve applied for something that requires qualification. This includes credit cards and loans. If you’re looking to open a new card, check your mail to see if you have offers where you’ve been pre-approved, as those types of credit checks do not impact your credit report.
Deal with your delinquencies/ past-due accounts. If you have past due bills or old credit accounts you’re not using, then you’ll want to deal with those.
For bills, pay them off as soon as you can. Having bills go to collections will negatively impact your credit score.
For unused credit accounts, you should close them. Closing them will not remove them from your credit report; it’s just important that you know everything that is open under your name.
Understand your debt. Once you see what you have as your debt, the next critical step is to make a plan to pay it down, so you carry less of a load. Try to get your collections and delinquencies taken care of first, then work to pay off your high-interest credit debt so you can get it out of the way.
If you’re unsure how to handle your debt, you can speak to a debt consolidation service that can help you reduce your debt by making deals with your creditors and setting up more affordable monthly payments.
How long does it take to improve your credit score?
Improving your credit score is a path that takes time. If your credit score is lower, you may see improvements faster than if your score is already high. While there isn’t a specific time frame that can be applied to everyone equally, you should begin to see improvements within 30 days once you start working on your score.
The key is to form a plan to reduce your debt and be consistent with it. You will see improvement!
Why is your credit score important?
Your credit score is important because it helps determine many things, from interest rates to cell phone plans. Here’s a list of things that your credit score will impact:
- It will help you qualify for better interest rates.
- You can qualify for loans for a higher amount.
- You may get better cell phone plans.
- You’ll be pre-approved for better credit cards with higher credit limits.
- Better/easier approval for apartments and rental homes.
- Better car insurance rates.
- You may be able to avoid paying security deposits on things like cell phones and utilities.
Having a good credit score increases your ability to negotiate for lower rates on cards and loans, as well.
Improving your credit score is a crucial part of your financial foundation. For example, if you’re looking to purchase a home, your credit score can determine the type of loans you can get, as well as your interest rates.