Building and maintaining a respectable credit score is an important part of your financial life.
With a good credit score, you can qualify for the best loans at the lowest rates, earn cash rewards with responsible credit card use, and more.
But how do you actually earn a great score? If you don’t know what to do, you may end up with a poor credit score rather than a good one. And if you have a low credit score, you might be wondering how to improve it.
Although there are plenty of companies that can help you improve your credit score, you can do it on your own for free. A DIY approach to building or fixing your credit is an effective way to learn good money management principles.
What is a Credit Score?
Your credit score is a calculation based on a number of factors including the type of open accounts, payment history, and the amount of your debt. Your credit score indicates your ability to repay a loan, and lenders use it to determine if they should lend you money.
Your credit score can also affect how much of a down payment you might need when buying a house or when your credit line increases. If you have a high credit score, you might get away with a lower down payment than if you had a worse credit score.
Credit scores typically fall into a range, and the higher your score, the more likely you are to secure a loan with a good interest rate.
|FICO® Credit Score||Rating||Potential Impact|
|300-579||Very Poor||Applicants with this rating may not be approved by lenders at all or may be required to pay fees or deposits or have a co-signer for a loan.|
|580-669||Poor||Applicants with this rating are considered by lenders to be “subprime,” so the interest rates they qualify for are some of the highest.|
|670-739||Good||Only a small percentage of these applicants are predicted to become delinquent on payments, so lenders are likely to approve them.|
|740-799||Very Good||Applicants with this rating are likely to receive better-than-average interest rates on loans.|
|800-850||Excellent||Applicants with this rating will get the very best available interest rates from lenders.|
7 Ways to Improve Your Credit Score
If your score is on the lower end, or you’re just getting started building your credit, here are seven steps you can follow.
1. Obtain and monitor your credit score.
To improve your credit score, you need to know what your credit score is now. You can do that by obtaining a copy of your credit report.
You’re allowed one free credit report, accessible via AnnualCreditReport.com, from each of the three major credit bureaus (Equifax, TransUnion, Experian) every year. If you stagger these throughout the year and mark it on your calendar – once every four months, for example – you can watch closely for any errors. It’s also a good way to see if your efforts to improve your score are working.
While there are paid credit monitoring services out there, you can do it yourself for free through a service like Credit Karma or Credit Sesame. You’ll also be notified when there are changes – good or bad – to your credit report.
2. Pay your bills on time.
Since 35% of your credit score is determined by your payment history, paying your bills on time is the best thing you can do to help your credit score.
Even one payment that’s 30 days late can decrease your credit score by up to 100 points or more, according to FICO. Late payments stay on your credit report for a full seven years.
To avoid late payments, consider:
- Setting your bills to autopay
- Writing the due date on your calendar
- Setting up reminders on your phone or tablet
- Using a bill reminder system from Mint
If you switch to a new bank account, make sure to update your autopay information so your payments don’t get rejected.
3. Dispute previous negative remarks and incorrect late payments.
According to an FTC survey, 25% of Americans have an error on their credit report. And 20% of those people had an error that could hurt their ability to get a loan. If you find an error on your credit report, don’t freak out. You can dispute the error with each of the three credit bureaus.
Once you dispute a mark on your credit report, the credit bureaus are legally obligated to investigate and remove the mark if it’s found to be invalid. You can contact each of the three credit bureaus here:
Make sure you follow up by checking your credit report approximately 30 days after you’ve filed your dispute. If the error remains, you may need to contact the company again. You have to be your own advocate when it comes to errors on your credit report.
4. Lower your credit utilization.
Credit utilization refers to the percentage of available credit you’re using. If you have two credit cards with a total limit of $10,000 and a balance of $500 on each card, then your credit utilization ratio is 10%.
The lower your credit utilization ratio, the better. Many credit experts recommend keeping it at under 30% of the total available credit. This refers to both the utilization on each of the cards separately and your total utilization limit across all cards and lines of credit.
Since 30% of your credit score is determined by your credit utilization, one of the easiest ways to improve your score is to pay off your debt. You might even see a boost in your score within a week or two once you start paying down your credit card balances.
5. Diversify your credit mix.
Your credit mix, or the types of credit you have, makes up 10% of your overall score so you can boost your score by having a mix of different types of credit. There are two types of credit. These are revolving accounts, which include credit cards, and installment accounts, that include a mortgage or student loans. Having multiple accounts of each type can increase your credit score.
That doesn’t mean you should take out an installment loan if you don’t have one, just for the sake of improving your credit mix. If your only debt comes from student loans, don’t go into credit card debt just to improve your credit score.
6. Reconsider closing old credit cards.
When you pay off a balance on a credit card, you might be tempted to close it to prevent yourself from using it in the future. However, the amount of time that your accounts have been open comprises an additional 15% of your credit score. Keeping them open – even ones with a zero balance – can raise your score, especially if it’s a card you’ve had for a long time.
When you close an account, your credit history will shorten and your credit score may drop. As long as your card doesn’t come with an annual fee, consider keeping it open. If you do use it, pay off the balance in full whenever possible.
7. Keep hard inquiries to a minimum.
If you need to take out a loan, you can often check your rate with different lenders for free. This generally results in a soft credit check or a soft credit pull, where the lender gets access to a limited version of your credit report. These don’t harm your credit score.
But once you’re ready to apply for a loan, the lender may require a hard credit check or a hard credit pull. In this case, the lender gets full access to your credit report. Since each hard inquiry can cause your credit score to drop, it’s a good idea to wait until you’re truly ready to apply with a lender.
If you’re shopping for an auto loan or a mortgage specifically, you can check your rate via hard inquiry with multiple lenders and not be penalized, as long as you do all your rate shopping within a 30-day period. In this case, all the separate inquiries will be treated as a single inquiry on your credit report.
A Good Credit Score Provides More Options
Although some popular personal finance personalities, like Dave Ramsey, say your credit score shouldn’t matter because you shouldn’t have any debt in the first place, it’s still a good idea to monitor it. Even if you don’t have any debt, or don’t plan on taking on any, your credit score can still affect other facets of your financial life.
- Easier access to future credit. Even if you don’t need credit now, you might in the future. You might exhaust your emergency fund and need a loan for a major expense, or you might want to buy a house and don’t have enough cash saved. When that time comes, it’s better to have a good credit score so you can qualify for the best loans. It also means you can avoid predatory loans like payday loans, which are often the only option for those with poor credit.
- Lower car insurance premiums. Car insurance companies may use your credit score when determining your auto insurance rates. According to a study from Taylor & Francis Group, customers with higher credit scores are statistically less likely to involve themselves in auto accidents, so companies charge accordingly.
- Potential landlords may check your score. Even if you’re not planning on buying a house, you’ll still need a place to live. As a renter, having a good credit score is important. Many landlords will check your credit score during the application process so they know you’ll pay your rent on time. If you have a bad credit score, you could be denied an apartment, be asked to have a co-signer, or have to pay a larger security deposit.
- Lower interest rates. When you apply for a loan, you want to be approved for a loan with the lowest possible rate. Even the difference of a few percentage points can mean big savings. For instance, you’ll pay an additional $346,552 in interest if you have a 4.5% vs. a 7.5% interest rate on a 30-year, $500,000 mortgage. That’s a huge difference.
- Getting a job. Some jobs, mostly in the government, financial, and law enforcement sectors, may require a credit check. Even if you’re looking for work in a field that doesn’t typically require a credit check, having a good credit score is one thing you won’t have to stress about should a prospective employer require one.
Improving Your Credit Score Helps Your Overall Finances
Just like more money means more options, a good credit score means more opportunities. While obtaining a good credit score can seem complicated and confusing at first, with patience, persistence, and dedication, it is possible to do it yourself.
Even better, the things you do to set yourself up for a healthy credit score will also set you up for a healthy financial life. By paying your bills on time, maintaining low balances on your credit cards, and keeping an eye on your credit score, you’ll be well on your way to a brighter financial future.