Insider’s experts choose the best products and services to help make smart decisions with your money (here’s how). In some cases, we receive a commission from our partners, however, our opinions are our own. Terms apply to offers listed on this page.
- Making on-time payments is essential to boosting your credit score.
- Paying off debt and bringing past due accounts current can also improve your credit score.
- Finally, you should always monitor your credit report to ensure there are no errors or inaccuracies.
- Read more stories from Personal Finance Insider.
Your credit score is a number that represents how likely you are to pay off your debts, from credit cards to car loans to mortgages. The higher your credit score, the more likely you are to pay off what you owe — and the more creditworthy you’ll be considered by financial institutions.
Credit scores play an important role in financial freedom because they’re a big factor that can better your chances of getting the financing you need for everything from day-to-day purchases to major life purchases such as a home.
Because of this, your various credit scores can sometimes vary at any given time.
Understand how credit scores work
In general, your credit scores fall in a range between 300 and 850, which are determined by the information recorded in your credit reports.
In addition to your personal information such as address and birthdate, credit reports also list your current and previous employers as well as details on your various credit accounts. For instance, it will list a credit card account, when it was opened, the current balance at the time of the report, and your payment history (on-time, late, and missed payments).
You also have more than one credit score, too, which are calculated by the three major credit reporting agencies: Equifax, Experian, and TransUnion. These three bureaus compile information about consumers’ financial dealings and use that information to calculate your credit scores, which are then used by lenders to determine how likely you are to pay back a loan.
Then there’s another organization known as the Fair Isaac Corporation, or FICO, which is a data analytics and software company that uses its own proprietary algorithm to calculate consumer credit scores.
The FICO score looks at five key elements to determine your specific credit score:
- 35% payment history: A FICO score’s most important factor, paying your bills on time helps a lender determine your risk for repaying the debt.
- 30% amounts owed: If you have a high debt level, lenders may see that as a potential risk that you may not be able to repay your credit cards or loans.
- 15% length of credit history: It’s important to show you have honored your debts in the past. Lenders look at how long you’ve had credit accounts and how often you use them.
- 10% new credit: If you open a lot of new accounts in a short period of time, that could be a red flag for lenders.
- 10% credit mix: FICO scores take into account the various types of credit accounts have, from mortgages to student loans to credit cards and other financing products.
Generally, a credit score below 670 is considered to be poor or fair credit. If you’re among those who have a credit score around that area, you will find it difficult to get approved for loans, credit cards, or other financial products. And if you’re approved, your APR will be very high, which isn’t ideal.
But luckily, there are steps you can take to start improving your credit.
1. Limit your credit utilization
Your credit utilization ratio examines how much of your available credit you currently use. For instance, if you have $10,000 available in credit cards and have a total balance due on those cards of $5,000, your credit utilization ratio is 50%.
“The ideal credit utilization ratio is under 30%,” says Brandon R. Amaral, CFP, EA, founder and financial planner at Amaral Financial Planning LLC in San Jose, Calif. To remain below 30%, he recommends his clients reduce their spending or request a credit limit increase. “If your income has increased, most credit card companies are happy to increase your credit limit,” he says.
2. Pay off your credit cards in full and on time each month
When you use and pay off your credit card each month, you build a history of responsibly using credit. Because payment history makes up 35% of your credit scores, regular on-time payments goes a long way in boosting your credit score. In addition, if you pay off your credit cards in full each month, you will save on interest, and you can direct those savings to other debts or add to your retirement accounts.
3. Avoid applying for new lines of credit
Every time you apply for a new line of credit, the credit reporting agencies receive what is called a “hard inquiry.” Too many hard inquiries can actually lower your credit score. New credit lines also can negatively impact the age of your accounts that show a strong credit history.
“Every time you apply for a new line of credit, your credit score will initially drop,” Amaral says. “This is because your ‘average account age’ will decrease from adding new credit cards.”
Another cause for concern with new lines of credit is the bump up in available credit. You might feel like you can spend more if you have a big line of credit, which can lead to overspending. If you’re unable to afford this level of spending, you risk late or missed payments that will lower your credit scores. In addition, applying for new lines of credit too often could signify that you’re not responsible with money.
4. Keep old credit accounts open
Because your FICO scores are partially based on how old your credit accounts are, if you close older accounts, your credit scores may drop.
Another reason closing a credit card can hurt your credit is because its credit limit wont be included in your utilization ratio. “The reason is that your payment history is a significant factor in determining your credit score, so closing an old card that has most of your good payment history will hurt your score,” Amaral says. “What they can do is place a small, recurring bill on that credit card, so that it continues to build history and isn’t at risk of being closed due to inactivity.”
5. Resolve any accounts that are past due
Bringing past-due accounts current is a key step in improving your credit scores. Remember that payment history is 35% of your credit scores, so the sooner you have a positive payment history, the better.
Amaral suggests reviewing the payment plan and interest rates for each loan and/or credit card, and developing a strategy to pay off the loans or accounts to minimize the interest they will pay. Once the accounts are current, you can revise your payment plan to pay the accounts each month in order to pay off the entire balance.
6. Develop your thin credit file
Sometimes someone has bad or no credit because they simply never developed credit in the first place. If you’re not able to qualify for credit on your own, there are some steps you can take to start building a credit history.
- Become an authorized user on someone’s credit card. “Authorized users can see an increase in their credit score because the payment history for the primary cardholder will be reported under their credit file,” Amaral says.
- Apply for a secured credit card. “Secured credit cards usually require a small security deposit, but will allow you to start building a history of payments,” Amaral says.
- Get credit for your on-time rent payments. (although not considered by every scoring model) using a rent reporting service. A rent reporting service is a third-party company that collects your rent for your property manager and, in turn, reports those payments to the crediting reporting agencies. There is a fee for this service, which may be paid by your property manager or you.
7. Monitor your credit scores and track your progress
It’s important to track your credit scores as you take these steps to increase your credit. After all, you want to make sure the work you are doing is getting the results you want.
“There are a few resources available to monitor your credit score without requesting a hard inquiry,” Amaral says. You can find service providers online who allow you to review your full credit report and track changes to your score for free. In addition, some credit card companies offer the ability to check your credit score for free, although these scores may not be the same as the scores provided by the credit reporting agencies.
You also can receive a free credit report each year from the three credit reporting agencies by going to annualcreditreport.com. Use this tool to review your credit report, and report any mistakes to the credit reporting agencies. Having a correct credit report is essential to boosting your credit score.
The financial takeaway
Paying your credit card bills and loans on time is the best first step to improving your credit scores. If you have delinquent accounts, make a plan right away to bring them current so the late and/or missed payments will not continue to hurt your credit scores.
Keeping your credit cards paid off or maintaining low balances will help improve your credit utilization ratio, which should be less than 30% of your available credit.
When you do pay off your credit cards, don’t close those accounts. Instead, keep them open so you don’t lose the payment history. This also boosts the “age” of your accounts, which also affects your credit scores. Remember to monitor your credit report to make sure it’s accurate. Mistakes can harm your credit scores and should be quickly corrected.
