Whenever you are applying for credit – every single time you are applying to borrow capital from an institution – the lender wants to know what degree of risk they are taking on. Can you be trusted to pay the money back on time? Do you have a track record of managing your debt well?
A credit score is an overall gauge of how creditworthy a person is. When a person wants to access credit, an institution will use this three-digit number to decide whether or not to extend the credit line.
Your credit score plays a crucial role in your life. Which means you should be actively working to build your credit score – especially if you’ve had any previous credit hiccups. There are lots of ways to make a good credit score even better, or quickly improve a low one.
Most credit scores are on a 300 to 850 scale. The higher the better. Most credit scores fall between 600 and 750. A score of 700 or above is generally considered good. A score of 800 or above is considered excellent.
A lot of financial factors and habits affect the rise and fall of your credit scores. This is why the question of how to build your credit score is a complex one.
Credit bureaus use a sophisticated formula to calculate a credit score, but for the sake of making things easier to understand, here are the factors they consider:
Payment History is the biggest contributing factor, accounting for over a third of your credit score. Lenders want to know whether you are a person who repays your future debts on time and as agreed. Late and missed payments do damage here, as do foreclosures and bankruptcies.
Credit Utilization A very important metric, this measures the credit you’ve actually used against your available credit. You want to keep the amount you've used as far below the amount you’re allowed as possible, in order to keep a lower “credit utilization ratio.”
Types of Tradeline is the type of account that appears on your credit report. Lenders want to know what sort of credit you have accessed in the past and why. The composition of your tradelines – how your report mixes together auto loans, student loans, credit cards, and other types of debt – is important. For example, occasional delayed mortgage payments are less worrisome than multiple unpaid jewelry loans.
The Number of Applications you submit for new credit accounts also affects your credit score. The impact depends on how many new credit accounts you’ve applied for, versus the total number of tradelines on your credit report. Too many new applications, especially if a lot are submitted in a short amount of time, can pull down your score. These are also called "hard inquiries." Soft inquiries, where you pull your score for educational or prequalification purposes, do not affect your score.
Length of Credit History the longer you’ve shown good financial habits, the better. A sparse, new credit record is a concern for lenders. In addition, a new tradeline that you just opened will initially lower your score before you start to add good payment history to the tradeline.
The ten best tips on how to
build your credit score
1. Know what you’re working with
You’re allowed to see a basic credit report from the big three credit bureaus – Experian, TransUnion and Equifax – for free, once a year at AnnualCreditReport.com. Or you can use services like CreditKarma or Credit.com for a very detailed, on-demand report. This is called a soft inquiry. Review your report carefully and check for mistakes or inaccuracies. Staying in the know = staying on track to a better score.
2. Correct any errors that you see on your credit report
Does something not look right? If you don't recognize something on your credit report, or if what you see does not reflect reality, you can 'dispute' it. Each bureau has a way to file a dispute - you'll usually have to provide proof, and may be required to work with the original creditor, but any errors are correctable and the creditors are required to respond within one month.
3. Make on-time payments
There’s no better way to establish a solid credit history than by consistently making your payments in full and on time, every time. This is the backbone of a good credit score. Even if you’ve erred in the past, a recent period of consistency produces good effects, fast. If you can't pay in full, definitely pay something!
4. Get credit for every rent and utility payment you make
More than a third of Americans rent their home, and their rental payment is their biggest expense. Your on-time rent payments can help lift your score too, as long as they’re reported to the bureaus by a data furnisher like LevelCredit. This is a great way to build your credit score without incurring any debt.
5. Settle Debts
Another simple one. Pay old bills, even if they’re long overdue. Doing this increases your amount of available credit, and in turn, your score.
6. Keep Old Accounts
Even after settling or paying down your debts, try to keep the accounts open. Having the credit available to you, but not in use, will lift your score by lowering your credit utilization ratio (the total amount of credit you have compared to how much you use). Not all account types can be left open, but credit cards certainly can.
7. Ask for an Increase
One simple way to build your score is to ask for a credit increase from your card issuer. You won't always get it, and they may have to check your credit again in order to do so, but the resulting decrease in overall 'utilization' could help your score.
8. Limit credit applications
When you apply for a new credit account, the lender pulls your credit report (also known as a “hard inquiry”), which temporarily lowers your score. Only apply for credit when you’re ready, you’re sure you want it, and you’re confident your application won’t be rejected. However, you can apply to additional lenders of the same time within a 30 day period without affecting your score further - this allows you to "shop" a mortgage, for example.
9. Mix it up
Diversifying your debt and juggling different payments shows savvy. Installment loans, credit cards, and auto loans are all great to have. Rather than having one or two debt black holes that you can’t get out of, spread what you owe around and consolidate debit into a personal loan, for example. Better to be hitting multiple smaller payments than repeatedly failing fewer large payments.
10. Don’t be afraid to use your credit card - responsibly
Lenders like to see people using their credit in responsible ways. Even just one small purchase per month that you consistently pay off will positively impact your credit score (as long as you pay your bill at the end of the month!)
There are also some common misconceptions on how to build your credit score. People think these factors/behaviors affect credit scoring when, actually, they don’t:
- Your employment history might appear on your credit reports, but it won’t affect your score. Similarly, your salary has no impact on your credit score.
- The amount of money in your bank accounts or other financial assets doesn’t impact your credit score.
- Looking at your own credit reports is considered a “soft inquiry” and doesn’t affect your credit score.
- Marriage or divorce might impact your finances, but don't expect either to necessarily bump your credit score up or down. Credit scores are per individual, not per couple.
- It’s true that the demographic connections between credit scores and age, gender, and location are interesting, but none of this matters when it comes to your score. Fair lending laws prohibit this kind of tracking or discrimination.