Improve Your Credit Score!
I’m a big advocate for not borrowing money. However, most of us borrow to own a home. Having a good credit score can help save you money on interest rates. Even a 0.25% difference in interest rate makes a huge difference over the life of a mortgage. Credit scores can even affect insurance rates, and whether or not you get that job you applied for. So, it is important to maintain a good credit score.
Your credit score is made up of 5 categories, and each category is weighted in the percentages shown in the chart above. Paying attention to this and making small changes will help improve your credit score.
Payment History: This makes up 35% of your credit score. Your score shows a lender how big of a risk you are at defaulting or paying late, so it’s obvious why this is heavily weighted in your score. If you have been late on payments in the past, paying all of your bills on time will have the biggest positive effect on your score.
Amounts Owed: This makes up 30% of your score and is calculated as a ratio of amount of credit available vs amount of credit used. It’s best to have credit available but not be using it. For example If you have a credit card that has a $1000 limit and you have $900 on it, 90% of your credit is used and 10% is available. This is bad for your credit score. If you had a credit card with a $9000 limit, and you had the same $900 on it, 10% of your credit is used and 90% is available. This is good for your credit score. The best thing to do is pay off your debts so that you have a low ratio of credit used to credit available. However, you can actually increase your credit score by getting your credit lines raised. If you’re the person that has $900 on a credit line with $1000 limit, ask for an increase on your limit, it can make a big difference. Just don’t use that extra credit, or you’ll dig yourself in a deeper hole! I highly recommend not using credit cards unless you can pay of the balance at the end of the month. Some people will say paying off your credit cards hurts your score, but I have never carried a credit card balance and my score is close to 800. I’m sure I could bump it up a few points If I left 1% of the credit limit on each card, but it’s not worth it at that point.
Length of Credit History: This is how long you have had different credit lines open and it makes up 15% of your credit score. If you have a 10 year old credit card that you never use anymore it can be beneficial to leave it open rather than close it. The credit agencies like to see a long history on accounts.
New Credit Accounts: A better way of saying this is credit inquiries. This makes up 10% of your credit score. The number of places you have recently applied for credit can actually hurt your credit score. It shows the credit bureau that your looking for credit. For instance, if you were looking at cars and the car dealership ran your credit to see if you qualified (even if you didn’t buy), then the following later you apply for a mortgage, the car dealership running your credit will have actually reduced your score by a few points. So, try to avoid having your credit checked if you’re not sure you will follow through with what you are applying for.
Types of Credit Used: This is also weighted at 10% of your score. The credit bureaus like to see different types of credit utilized. Ideally a person would have 3-5 revolving lines of credit (credit cards or department store cards), 1 mortgage, and 1 car loan (of course all with low balances). A good mix of credit helps, but if you start having multiple mortgages and multiple car loans it can actually hurt your score.
In summary paying attention to the way credit is scored and using your money responsibly will have a big impact on your credit score. Since I prefer not to use much debt, because I perceive debt as risk, I prefer not to borrow money on cars or credit cards. I’ll drive a beater car before getting a loan on something that goes down in value. I’ve found that I can keep my credit score in the highest bracket just by having a mortgage that gets paid on time, a few credit cards that get paid off every month (or don’t get used), and a home equity line of credit that is paid off (but still open).
If you’d like to check your credit report for free go to www.annualcreditreport.com . This is a legitimate government backed site. It will not show you your score but it will give you a fully detailed credit report. Just make sure you decline any extra services they offer.
To get a free credit score try www.creditkarma.com . This site is not your actual score from the three main credit bureaus but it’s an independent estimate of your score and it’s extremely close to reality. I use it myself and my score is within 3 points of my Trans Union score.