Your credit score affects just about everything you do. Landlords check your credit report before agreeing to rent you an apartment. Mortgage lenders check your credit before giving you a loan to buy a house, and even auto insurance companies check your credit before issuing you a policy.
These are the factors that determine your credit score:
- Payment history – 35% – This is a record of your on-time and late payments for all of your credit accounts. It's a report card showing how you handle your finances. Payments more than 30 days late get posted as a negative mark on your profile and remain on your report for seven years.
- Credit utilization – 30% – This is the amount of debt you owe, known as the credit utilization ratio, on your credit cards relative to the total maximum amount of the credit lines. The goal is to keep this ratio at 30% or less.
- Length of credit history – 15% – A history over several years of on-time payments shows that you handle your finances responsibly.
- Credit mix – 10% – Having a mix of credit card debt and installment loans is better because it shows that you can manage different types of credit.
- Credit inquiries – 10% – Each application that you make for credit generates a "hard inquiry." Too many inquiries in a short time could be an indication of financial problems. Even worse, each hard inquiry has a slightly negative effect on your credit score.
Let's look at the steps you can take to improve your credit score.
Get Copies of Your Credit Reports
The first step is to get copies of your credit reports. The U.S. government allows you to get a free credit report from all three credit bureaus (Transunion, Experian and Equifax) once per year at AnnualCreditReport.com.
Once you get this information, you can go to work and start finding ways to improve your credit score.
Look for Any Negative Information
After you receive the credit reports, go through each one and highlight any accounts with a negative status. Look for:
- Collection accounts
- Reports of late payments
- Credit inquiries
- Incorrect current or past addresses
This includes any collections, charge-offs or anything on the public record such as judgments and tax liens.
Correct Any Errors
Make sure all of the accounts listed are your accounts, in your name and with the correct address. If you see any errors, file a dispute with the credit bureaus.
If you don't think you owe the money, send a letter to the collection agency or the company and ask them for proof by sending documentation that validates the debt. They have 30 days to respond.
Bring Any Past-Due Accounts Current
Accounts that are past due 60, 90 or more days have a more serious impact on your score than an account that is only 30 days past due. You want to get these accounts current before the creditor sends your account to a collections agency.
If the amount you owe is large, and you can't pay it all off at one time, negotiate a payment plan with the company to bring the account current.
Keeping payments current will have a continuous positive effect on your credit score. Late payments will still appear on your credit report but will have less effect over time.
Pay Off Any Collections
The latest scoring models do not consider collections with zero balances when calculating your score. The collection and payment history from the original creditor will still be reported.
Unfortunately, many lenders are still using older credit scoring models that are affected by outstanding collections, even when paid off.
If you can wait it out, collections should drop off your credit report after seven years.
Reduce Credit Card Debt
The amount of credit card debt you owe compared to the credit limits is known as the credit utilization ratio. Creditors like to see this ratio at 30% or less.
For example, if the credit limit for all your cards adds up to a maximum limit of $10,000 and your total credit card debt is $6,500, then your credit utilization is 65 percent. Your goal, therefore, is to reduce your credit card debt to $3,000, or 30 percent of the maximum limit.
Unless you experience a sudden windfall of money, reducing your credit card debt may not be easy. You should start by making a budget and looking for ways you could reduce your expenses and apply these reductions to your credit card debt, even if the additional payments are only $25 or $50 per month.
This may take a while, but with controlled spending, you should eventually be able to get your credit card debt down to the 30 percent level.
Ask Your Credit Card Issuer for an Increase
If your credit card issuer raises your maximum line of credit and your debt level stays the same, your utilization rate will go down.
Take the example above. If your maximum line of credit is increased to $13,000 and your debt remains at $6,500, your utilization rate drops to 50 percent ($6,500/$13,000).
Your 30 percent target utilization rate is now $3,900, instead of $3,000 as before the line was increased.
However, you must maintain your discipline by sticking to your budget and resisting the temptation to spend more because you have an increase in your line of credit.
Long-term Steps to Take
Become an authorized user – Ask a friend or relative with a high credit score if they would be willing to add you as an authorized user on their account. Their good account history will go into the calculation of your credit score.
Increase credit card payments – Make more than the minimum payment on your credit cards, and make payments twice a month instead of once. Smaller payments are easier to make, and you'll see faster reductions in your credit utilization.
Keep unused credit cards – Don't close any unused credit cards. This will reduce your total available credit and increase your credit utilization percentage, negatively affecting your credit score.
Use different kinds of credit – Maintain a mix of different types of credit. FICO favors consumers with both credit cards and installment loans, such as mortgages and car loans.
Don't open new accounts – Don't apply to open any new accounts unless you absolutely need to. Each new application creates a “hard inquiry” at the credit bureaus. A large number of inquiries over the past two years will lower your credit score.
Changes in your credit score won't take place overnight. But if you prepare a plan and invest the time and money into it, you can make serious changes in your credit score in less than a year.
- Experian: How to Improve Your Credit Score
- Credit Karma: What Should I Know if I Have Debts in Collection?
- Nerdwallet: How Long Do Derogatory Marks Stay on Your Credit?
- Credit.com: How to Remove Collection Accounts From Your Credit Reports
- AnnualCreditReport.com: Free Credit Reports
- Credit Karma: Free Credit Scores
- Credit Sesame: Free Credit Scores
- myFICO. "What's in My FICO Scores?" Accessed Oct. 4, 2019.
- myFICO. "New Credit," Accessed Oct. 4, 2019.
- Equifax. "Understanding Hard Inquiries on Your Credit Report," Accessed Oct. 4, 2019.
- myFICO. "Credit Checks: What Are Credit Inquiries and How Do They Affect Your FICO Score?" Accessed Oct. 4, 2019.
- VantageScore. "Did You Know…The Optimal Credit Card Utilization Percentage Is…" Accessed Oct. 4, 2019.
- Experian. "What Is a Credit Utilization Rate?" Accessed Oct. 4, 2019.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.