Money Matters: How to build a better credit score
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A credit score is a numerical representation of an individual’s creditworthiness. It is a three-digit number that ranges from 300 to 850. The higher the score, the better the creditworthiness. A person’s credit score can significantly impact their life — for good or ill. A good credit score can help someone to obtain a loan, get approved for an apartment rental or receive better terms on a loan or lease. Poor credit, on the other hand, can make it more difficult for individuals to achieve certain life goals.
Given the weight that credit bears on financial outcomes, it comes as a surprise that almost 40% of Americans have no idea what factors determine their credit score. In this article, we will discuss the five contributors to your score and how to build a better credit score.
Pay your bills on time
Payment history makes up 35% of a credit score, making it the largest contributing factor to your score. Consistent, on-time payments increase a person’s credit score, while late payments can lead to a huge plummet in credit.
According to a report by FICO, one missed payment can cause a credit score to drop by 90 to 110 points, depending on the score before the missed payment. This drop can significantly affect a person’s chances of obtaining a loan. Therefore, it is crucial to make payments on time if a strong credit score is the goal.
One way to ensure that you make payments on time is to set up automatic payments in the banking system or app connected to your credit card. As long as you have enough cash in your checking or savings account to pay off your monthly balances, your credit card balance will be automatically paid without any direct involvement on your part. Recurring automatic payments will save you from the headache, fees and credit drops associated with a missed payment.
Keep credit card balances low
Credit utilization is the second-largest percentage among the five factors that contribute to a credit score, accounting for 30% of the total score. A person’s utilization is calculated by comparing the amount of credit a person uses compared to the credit they have available. For example, a credit limit of $5,000 combined with a high credit utilization rate can signify poor money-management habits and cause a credit score to plummet.
According to Experian, people with the best credit scores typically have a credit utilization rate of 10% or less. Moreover, it is advisable to keep your credit utilization below 30% of the credit limit whenever possible, as utilization higher than 30% disproportionately affects your credit score and may deter potential lenders.
You can keep your credit utilization low through one of a few different methods:
- Pay off your credit cards more frequently than your required payment dates. This way, your total utilization rate will remain low throughout the month.
- Make sure you pay in full each month — or as close to a full payment as you can afford. Like the first method, paying off your credit card in full every month will ensure that your utilization rate is low when your credit score is calculated.
Build a credit history
At 15% of the total credit score, credit history is the third-largest determinant of a credit score. Credit history is the length of time a person has had credit accounts open. A longer credit history signifies higher creditworthiness — especially when an account with a longer history has healthy utilization and on-time payments.
A recent study by FICO confirms that the old adage of “age before beauty” holds true when it comes to credit scores. Generally speaking, older individuals have a longer credit history and higher credit scores to match. However, older credit users not only have longer credit histories that boost their scores but also have not missed a payment in a longer period of time than younger credit users. To achieve an optimal credit score, it is essential to start building a credit history early. With age comes experience (and strong credit).
Have a mix of credit accounts
Having a variety of credit accounts can also elevate a credit score. A credit mix is the combination of different types of credit accounts, such as credit cards, auto loans and mortgages. There are four main types of credit that can contribute to a credit mix:
- Installment loans.
- Revolving debt.
- Mortgage accounts.
- Open accounts.
A diverse credit mix can demonstrate to lenders that a person can responsibly manage different types of credit.
According to Credit Karma, having a healthy mix of credit accounts can make a positive difference on your credit score. However, credit mix only makes up 10% of a credit score. Therefore, it would be inadvisable to take on more debt than necessary or can be regularly paid off as a way to boost a credit score.
Monitor your credit reports
Frequently monitoring a credit report can help detect errors, fraud and identity theft. Errors or fraudulent activity can happen without a person’s knowledge and can significantly harm a credit score. According to the Federal Trade Commission, one in four consumers have errors on their credit reports that could affect their credit scores. Therefore, it is essential to check a credit report for errors and correct them promptly.
Like we discussed earlier, many Americans do not understand what factors make up their credit scores. Consistently checking your credit report can also help you to better understand your credit score and take action to improve it.
In conclusion, building a better credit score requires on-time payments, reasonable credit utilization, an established credit history, a mix of credit accounts and consistent monitoring. By following these tips, individuals can build an exemplary credit score and achieve their financial goals.
Jacob Bingham is a project manager at Stage Marketing, a full-service content marketing agency based in Provo.
