Why improve your credit score? You’ll want to show lenders your creditworthiness. If you create a track record of on-time payments and refrain from running up your credit card balance, that tells the lender you’re a solid credit risk. If your history indicates you're highly likely to repay the debt, the lender could offer better terms.
In the following, we’ll explain the benefits of improving your credit score. We’ll also show action steps to help you improve each area lenders look at, to get you on better financial footing!
What’s a good credit score?
The two major credit scoring systems, FICO and VantageScore, each use the range 300-850 credit score range.
As a rule of thumb, here are how credit score ranges break down.
- Bad: 300-629
- Fair: 630-689
- Good: 690-719
- Excellent: 720-850
If you have access to a free online credit score feature through your lender or bank, take advantage and check in regularly. You’ll gain a good understanding of where you stand as a loan prospect.
Improving my credit score: What’s in it for me?
Raising your credit score to the next category (from fair to good, for example) can bring you some real financial benefits.
Better lending terms
Shaving a percentage point from your loan may seem like small potatoes. When you crunch the numbers and look at the total costs, you can save thousands over the life of a loan. For example, on a $250,000 home mortgage, a percentage point can add another $40,000 to your total interest payments.
That’s not chump change.
Credit checks aren’t just for loans. Insurance companies, housing rentals and employers sometimes conduct credit checks. The belief here is looking at your credit history reveals something about your character: Are you the type who can follow through with agreements?
Improved financial health
When you actively work on the areas the credit score companies look for, you’ll establish many good financial habits right out of the gate. On-time payments, for example, can save you a lot of money and hassle because you don’t have to deal with late fees. Your credit score doesn’t measure everything, including your savings rate, checking balance or net worth. But it can give you a place to get started.
Action steps to improve your credit score
In the next section, we’ll look at how good financial habits connect to each area that lenders look at.
Solving problems often comes down to breaking things down to their most basic parts. Here, we’ll dig into the elements of the credit score and how to improve each area.
On-time payments have the biggest influence on your credit score. One late payment can make your score drop anywhere from 90 to 110 points. Not only that, it will show up on credit records for up to seven years. (Tip: If you’re a day late, don’t panic. Most lenders don’t report your late payment until you’re 30 days or more past due.)
Action steps to improve on-time payments
- Get organized with your bills. Make a list of what you owe every month so you can anticipate your expenses without being caught short.
- Don’t break the streak! Once you have several months of on-time payments under your belt, you should see an improvement.
- If you have a derogatory mark on your report due to a late payment, see if you can get it removed by sending a goodwill letter. Explain why the payment was late, take responsibility, and ask the lender to remove the derogatory mark from your credit report. (This works best if you’ve been back on track with on-time payments.)
Credit utilization ratio
This metric looks at credit cards and other revolving loans. (It’s not looking at what you owe on your vehicle loan vs. the original amount.)
When looking at your credit utilization ratio, creditors and lenders like to see a lower ratio.
Let’s say your credit card limits amount to $8,000, but you’re carrying a balance of $4,000. That gives you a debt-to-credit ratio of 50%. Lenders may then see you as a high-risk borrower because you could end up with too many commitments on your budget.
What’s the ideal credit-to-debt ratio? Aim for getting your debt lower than 30% of your total credit.
Action steps to improve your credit utilization ratio
- Start paying higher monthly payments, particularly if your credit utilization ratio is above 30%. Plug in an extra $50, $75, $100, whatever you can afford.
- When one debt is retired, roll the payment to the next debt. This is called the debt snowball.
- Apply extra money to your balance: tax refunds, gift money and bonuses.
- Create a monthly budget and check in with it weekly. This keeps your spending under control, and reduces your need to turn to credit to plug the gaps.
Once you build an unbroken track record of on-time payments and lower your debt ratio, you’ll start to see your credit score move upward.
This looks at the age of your oldest and newest accounts and finds the average age of your accounts. Lenders may also look at how often they’re used. This isn't as impactful as the on-time payments and debt ratios, but nonetheless worth consideration.
Action steps for oldest accounts
- Don't be hasty in closing older accounts. If you’re transferring debt to a low or zero interest line of credit, shutting down too many at once can be detrimental to your credit score. Keeping it may also help your debt ratio.
Recent inquiries/new accounts
Opening multiple credit lines and loans in two years could lower your credit score. The reason relates to your credit ratio: Acquiring too much debt too quickly can put you in the high-risk borrower category. Lenders prefer to see two or fewer inquiries within two years.
If you’re young and starting out, however, pacing yourself is easier said than done. In a brief window of time, you might have borrowed for school, your vehicle and maybe even opened a credit card or two.
Action plan for improving recent inquiries
- Look ahead for the next five years. Which loans would you likely be taking out? Maybe it will be time for a new car, or you’re hoping to refinance your mortgage.
- Set your lending priority list: What’s most likely to happen, and what would be nice to have?
- Be selective and pace yourself. Space out new loans and credit lines as much as possible.
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