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How to improve your credit score

The average American credit score is 625, which is far from perfect. Fortunately, you can take steps to improve yours. 

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    Computer chips are seen on credit cards in this photo illustration taken in Encinitas, Calif. There are many ways to boost your credit score, but prioritizing which debts to pay down first can make a difference.
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All sorts of things are harder when your credit score is less than awesome. You pay higher interest rates on your home, pay higher interest rates for your car, pay double the interest on your credit cards, and more for your auto insurance, too. My particular favorite is the utilities deposit, which is basically the power company holding your money ransom while they bet against you paying your bills on time.

The terrible truth is that people with bad credit are usually also the ones least able to afford all these extra finance charges. Clearly it pays to have good credit since the deck is stacked pretty hard against the folks who don't.

Luckily, there are some simple things you can do to improve your score. They often require budgeting and financial discipline, but the bottom line is that you are not stuck with your number.

Recommended: Five ways to get the most from your credit card

Know your number.

Before you start, you need to know what it is you're trying to improve, right? So your first task is to discover and memorize your credit score.

Several credit card providers have free credit trackers. It's not a substitute for a credit report, but if you have a card with one of these providers, it's free and a pretty good place to start. American Express, Bank of America, Barclaycard, Capital One, Chase, Citi, Discover, and several others all let card holders access their FICO scores free when logged in to their accounts.

Pay your bills on time.

Your payment history makes up 35% of your credit score. It has more influence on your score than anything else you do. The prescription here is clear: Pay your bills on time.

If that's easier said than done, then it's time to start making some phone calls. If you're having trouble paying your bills, call the companies you owe and see what can be worked out. If it's a medical bill, see if you can negotiate it down. Falling behind on student loans? Ask about an official deferment. Credit cards will sometimes let you pay a reduced amount and even forgive a portion of your debt if you can commit to on-time payments or a freeze on your line of credit. Most creditors will work with you, and once there's an official plan on the books for you to follow it all gets reported as being paid on-time.

Pay down your debt for a better credit utilization rate.

How much of your credit limit you're using accounts for 30% of your credit score. Conventional wisdom says you should keep it under 30%. For a super simplified example, let's say you have a $10,000 on your credit cards. You want to keep your balances at around $3,000 or less.

That 30% credit utilization number is misleading, though. I've seen it touted as a sort of magic number, which is a gross misinterpretation of the concept. You want to keep it below 30%. I prefer to think of credit utilization like a report card:

  • 10% (or 90% available credit) = A
  • 20% (or 80% available credit) = B
  • 30% (or 70% available credit) = C

Basically, 30% is the absolute most you should carry to get a passing grade and still needs improvement if you expect to make the honor roll next semester. Well, something like that, anyway. Just remember that a utilization rate of 0% here isn't the good thing you probably think it is since no credit utilization means no payment history to report. I'll get into why that's a bad thing a bit later.

Think of it this way: your payment history and credit utilization are the things that really show how responsible you are as a consumer. You pay your bills on time and you don't max out your cards. It's actually pretty simple, even if it's easier said than done in the real world.

Pay your debt down. The obvious tactic to improve your credit utilization is to simply pay down your debt. That means throwing as much money as you can spare at your credit card debt.

If you have multiple cards, the most effective way of paying them down is to concentrate on paying off the card with the highest interest rate first while making minimum payments on everything else. This method is pretty well documented, known as the "avalanche method" and works by prioritizing the debt that's costing you the most money in the long run.

Another method that's a bit slower but often more psychologically fulfilling is the "snowball method" which entails paying off your smallest balances first in order to get some quick wins and build the momentum you'll need to stick to the plan over a longer period of time.

Whichever method you choose, paying your debt down to under 30% of available credit as quickly as possible must be a priority.

Negotiate a lower interest rate. Seriously, just call your credit card issuer and ask if they'd be willing to lower your interest rate. You'll especially have a good chance of success here if you've got a good history of on time payments. The worst that can happen is that they say no, and if they say yes then you'll be saving some money in the long run - and you'll be able to rearrange your avalanche or snowball lists a little.

Increase your credit limits. Call your credit card company and ask for a credit increase. You can often do this without even talking to a human being since some companies offer it as a phone menu option or in your online account. This is not for the financially reckless. The trick here is that you want to increase your limits and then do not use it. Scoring a higher credit limit immediately lowers your credit utilization since the debt you carry is then a smaller percentage of your overall credit profile.

Note that the effectiveness of increasing your credit limits to make your credit utilization look better is controversial even among experts. Experian says rather bluntly that applying for new credit probably won't improve your score, and that's probably partly true. Credit cards that go unused sometimes don't count towards your overall credit score, so opening a new card just to raise your limits and improve your credit mix probably won't work. On the other hand, having more credit available on existing cards and proving you are disciplined enough to not use it is likely going to send the positive signal you're hoping for.

Don't close any cards, ever.

Depth and breadth are two more keys to your FICO score. The most important card to keep is the one you've had the longest since the age of your open accounts has an effect in on your score. Likewise, having four long-held credit cards is better than having just one since it demonstrates breadth.

Plus, if you close a card but still have outstanding debt elsewhere, you've just wrecked your credit utilization rate by jacking it up to a larger percentage of your overall credit. Not good.

If you've paid off a card, just put it in a drawer and don't worry about it.

Brad's Deals founder Brad Wilson wrote extensively about why he never closes his credit cards awhile back and it's definitely worth reading his take on the matter.

Keep your credit active.

One of the purposes of having a credit score is to prove you're a responsible user of credit. It seems really counterintuitive, but it's not good enough to simply pay off your credit cards and never use them again. Crazy as it sounds in the world of credit repair, part of proving you're a good credit consumer is actually using your credit.

Here's a real world example. Many years ago, I worked as a loan processor for a small bank. A very wealthy customer had paid off all of his debt and watched in horror as his credit score fell. Why would someone with plenty of money and zero debt be getting dinged on their credit score?

Well, your credit score does not take your savings or your net worth into account. The formula relies on payment histories and credit lines that get reported to the credit bureaus and ignores everything else you have and do. Frankly, the credit score formula doesn't really know the difference between Mark Zuckerberg and a guy who lives in a van down by the river. It's really unforgiving like that. When the credit bureaus can't see you making regular on-time payments on something, anything, they're less certain of your ability to do it. The further away you get from a verifiable payment history, the worse it gets. The data is simply insufficient and the formula just does not react well to that kind of ambiguity.

We solved our wealthy customer's problem by financing a relatively small purchase he could have easily paid cash for just so he'd have something reporting to the credit bureaus.

If you're lucky enough to have paid off all of your credit card debt, GOOD FOR YOU THAT'S COMPLETELY AWESOME, but keep a wary eye on your credit score. If you see it backsliding, you don't need a bank to bail you out. These days, you can hack the system for yourself pretty easily.

You've got Netflix, right? Or some similar low-cost recurring service that happens on the same day every month for exactly the same amount? Move that to your oldest paid off card, and then schedule an automatic monthly payment to your credit card to pay it off the day after it hits your account. Problem solved.

Why does it need to be your oldest paid off card? Because unused cards sometimes get dropped from your credit report after a few months of zero activity. It's like they don't exist. You always, always want your oldest card to exist to keep the length of your credit history as long as possible.

Take a good look at your credit report.

Pull a free copy of your credit report from AnnualCreditReport.com. This particular site is the one recommended by the Federal Trade Commission and by all accounts won't sell your info to any third parties, which is something a lot of free credit report sites do in order to stay in business. In short, stick to the one we've linked here. Once you have your credit report, look it over carefully.

Are there any mistakes?  Credit reporting mistakes are regrettably common. You can dispute errors directly with the credit bureaus reporting them. If they can't resolve it, you may need to call the creditor that's reporting the bad info to get it fixed.

Are there any delinquencies? Call the creditor reporting it. Ask if they can change or remove it. If the delinquency was definitely your fault, ask what you can do to fix it as quickly as possible. Explain that you're cleaning up your credit score. Be open about the steps you're taking to improve your credit. Whatever happens, don't resign yourself to letting your credit report be an inaccurate portrayal of your finances.

On small delinquencies, like an old medical bill you forgot about, or a final cable bill that was lost in the mail after you moved, it's not going to hurt anything to try disputing it, even if it's true. Many times a creditor won't bother to argue it if the amount is small enough to not be worth their time and effort. But is it worth yours? Absolutely.

Ask your good silent accounts to start reporting.

Think about the bills you pay monthly that aren't reporting to the credit bureaus. This could be your cable bill, your phone service, or even a utility. If it isn't reporting to the credit bureaus but you've got a perfect payment history with them, it may be worth calling them up to ask if they can start. It may not be possible, but if it is, then you've instantly diversified your credit mix and added a well-aged line with a good payment history. That should contribute nicely to a better credit score.

This article first appeared at Brad's Deals.

The Christian Science Monitor has assembled a diverse group of the best personal finance bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link in the blog description box above.

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