How to boost your credit score

How to boost your credit score

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Credit cards, car loans, mortgages – America’s economy runs on debt. If consumer debt is the engine, then credit scores are the motor oil, a key ingredient that keeps the parts working.

Your credit score is a three-digit grade that lenders use to determine how much you can borrow, and at what rates. Credit scores also are used by employers in hiring decisions, by landlords when screening tenants and by insurers when deciding how much to charge for coverage.

The metric most commonly used by lenders is the FICO score, created by Fair Isaac Corp. While there are different versions of the FICO score, the scale usually ranges from 300 to 850. The average score is about 700.

To land the best deals on mortgages and car loans, you’ll generally need a FICO score of 740 or higher. If your FICO score dips below 600, you’ll pay painfully high rates to borrow.

How credit scores are calculated

Fair Isaac doesn’t reveal the precise calculus behind its numbers, but these are the five main inputs into your credit score:

  • Prompt payments. Paying bills on time helps your credit score. Paying late hurts your score. Payment history is the single biggest factor in your FICO score, accounting for as much as 35% of your grade.
  • Amounts owed. Say you have a $10,000 credit limit on your credit card. The FICO score rewards you for using only $1,000 of that credit line. It punishes you for maxing out the credit limit. Try to limit your spending – your “credit utilization rate” – to about 30 percent of your limit. This factor makes up 30% of your score.
  • Length of credit history. FICO scores increase over time, as you build up a history of credit usage. This is why you shouldn’t close old credit cards. The length of your credit history accounts for up to 15% of your FICO score.
  • Credit mix. The FICO score calculations distinguish installment credit (mortgages, car loans and other debt with fixed monthly payments) from revolving credit (credit cards with amounts due that vary from month to month). FICO favors a variety of loan types. This accounts for up to 10% of your credit score.
  • Recent credit applications. Applying for a loan or credit card triggers a “hard inquiry” against your credit score. These inquiries typically lower your credit score by a few points.
  • Derogatory information. Foreclosures, bankruptcies and other defaults deliver a sharp blow to your credit score. However, the hit dissipates over time.

How to get a near-perfect credit score

Perfect might be a stretch, but you should shoot for a FICO score north of 800. A stellar credit score gives you access to cheap money and helps you use debt strategically. Here are six smart strategies:

  1. Use credit, but use it responsibly. In today’s economy, opting out of debt isn’t really an option.
  2. Never draw more than 50% of your available credit.
  3. Pay your bills on time and in full every month. To avoid late payments, automate your bill paying.
  4. Don’t carry more than one or two primary cards and two or three store cards.
  5. Use the same card for a long time; don’t switch frequently.
  6. Use a credit monitoring service. This will alert you to identity theft.

Perhaps most importantly, drop your ego. At some point in your life, you will face an annoying bill that you think is wrong. Pay it, then fight it.

Refusing to pay a $50 charge “out of principle” can cost far more than it’s worth. Here’s a cautionary tale: One consumer refused to pay a small medical bill that he thought was inaccurately charged. The provider reported the missed payment to the credit bureaus, and the patient saw his credit score plunge.

As a result, his borrowing costs soared, adding a full percentage point to the rate on his $300,000 loan. Not paying a $50 bill out of pride translated to $3,000 a year in added borrowing costs.

 


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