What is a credit score?
Your credit score is a rating of how likely you are to pay back money that you borrow. By combining several factors about your history with loans and credit cards, a credit score is a simple and elegant way to judge a person’s credit worthiness. Because of this, credit scores are looked at in a huge number of situations: from the obvious ones of applying for a car or home loan, to less obvious ones such as renting an apartment, buying car insurance, and sometimes even applying for a job!
The first step in mastering your credit score is knowing how it’s calculated. Here is the breakdown:
- Payment history = 35% (Do you make your payments on time?)
- Amount you owe = 30% (What percentage of your credit limit have you spent?)
- Length of credit history = 15% (For how long have you had credit accounts open?)
- New credit opened = 10% (How recently did you last apply for credit?)
- Types of credit you have = 10% (Do you have a car loan, student loan, credit card, mortgage, line of credit, etc?)
How Do I Check My Credit Score?
You should know that your credit report and credit score are two different things. Everyone is entitled to one free credit report each year, from each of the three reporting companies (three reports in total). These credit reports will list your full payment history and loan balance information on each of your accounts, but the likely won’t include the number score without an extra fee. To check your official free credit report simply go to https://www.annualcreditreport.com/
It is possible to get a free credit score too. My two favorite ways to get a free score are with the Discover FICO Credit Scorecard or from Credit Karma. This tool is free for anyone, whether you’re a Discover customer or not. Discover uses TransUnion data to give you a FICO numerical score as well as an overview of your credit health by breaking down all five score components!
What Is A Good Credit Score?
Credit scores range from 300 up to 850. We can break these scores down into 5 Tiers of credit:
- Exceptional = 800+
- Very Good = 749-799
- Good = 670-739
- Fair = 580-669
- Poor = 579-
People with Very Good and Exceptional credit will typically get the lowest interest rates on loans and credit cards. People with Good credit make up the biggest segment of the population with a US average credit score of 673. Those people with Fair credit can still expect to obtain loans, but because of the higher risk should expect higher interest rates and sometimes a security deposit. Finally, people with poor credit will often find difficulty with things beyond loans. Most people in the Poor category have gone through a bankruptcy, foreclosure, or repossession, and therefore will find trouble getting loans, getting car insurance, being approved for rental apartments, and even finding employment.
How Can I Improve My Credit Score?
Great news, you can improve your credit score! Don’t waste your money on those “credit fixing” companies. Everything they do, you can do by yourself for little to no cost.
1. Check your credit report for errors
Your credit report is different than your credit score. A credit report will show every account you’ve had, current or closed. Each account will show the available credit, high balance, and any missed or late payments.
There are three companies that independently keep track of your credit reports: Equifax, Experian, and TransUnion. You are entitled to one free credit report from EACH bureau, once per year.
Look over every account in detail, and make sure all of the information is accurate. Also make sure that all three bureaus have the same information. Sometimes you’ll see an error on only one or two of the reports.
2. Fix any errors you find
Getting rid of errors is the quickest way to improve your credit score. However, if you notice any errors on your credit report, it is your responsibility to request an investigation.
Entries that are clearly mistakes – wrong name, fraudulent activity, etc. – can be disputed by sending a letter to the credit reporting bureau. The FTC website offers a free guide for completing this process, including a sample dispute letter you can fill in and send.
Negative information like late payments, charge-offs and bankruptcies can only be reported for 7 years. If you notice negative items on your report that are older than 7 years, you can dispute these with the same letter.
The Fair Credit Reporting Act requires credit reporting companies to investigate your account within 30 days of receipt. To know exactly when the 30 days begins, be sure to send the dispute letter via Certified Mail to get a return receipt. Once the investigation is done you’ll receive notice of the decision. The credit reporting bureau will either provide evidence to you that the item was correct, or they will remove it from your report,
3. Don’t close or open any credit accounts.
Feel free to cut up your plastic cards, just don’t close the accounts! Account age and credit utilization make up 45% of your credit score. Each time you close an old account, it decreases your average credit age. This also decreases your available credit, which would then increase your credit utilization if you owe any balances on your cards.
The exception to this rule is for installment debt. Installment loans are things like car loans, home mortgages and personal loans. These items will close out automatically once you’ve made the final payment.
Your credit score also drops slightly each time you apply to open a new credit account. This goes for credit cards, car or home loans, and even things like cell phone plans. These credit checks stay on your report for 2 years.
4. Reduce your Spending
The second largest factor in your credit score is your credit utilization. Reducing the amount of money you owe is the single most important part of improving your score. There’s no trick here; either increase the amount of money you’re earning, or reduce the amount of money you’re spending. Check out my 99 Ways to Make Money for inspiration, and 9 Ways to Save Ruthlessly for a plan!
5. Automate your Finances
The worst thing you can do for your credit score is to miss payments or make late payments. Most lenders offer some form of automatic payments so you never have to remember a due date again. Start by asking your employer about setting up direct deposit for your pay check. Next, set up auto pay with your utilities, credit cards, and installment loans. I personally set my credit cards to make the minimum payment and add onto that manually, but set as agressive of a number as your budget will allow.
6. Make a Debt Payoff Plan
Start by making a list of every credit card you have, along with balances and interest rates. You can use this spreadsheet to make things easier.
A. Sort the accounts by either the highest interest rate first (debt avalanche) or lowest balance (debt snowball). Start at the top and work your way down until all your balances are closed out.
7. Find Reinforcements
Lately many more companies have been relying on credit scores for services. Because of this, many landlords, utility companies and even cell phone providers have started reporting your payments to credit bureaus as well. Call your electric company, water company, even garbage company too, and ask if they can report your payment history to the credit bureaus.
Experian is using this type of data to improve credit scores in their new service called “Experian Boost“. Boost links to your bank account and finds payments to utility and cell phone companies and adds them to your report automatically!
Follow all that and you’ll be well on your way to a top tier credit score!