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What can I do to improve my credit scores?
The short answer to this question is the following: You can improve your credit scores through responsible credit management. That’s what credit-scoring models want to see. This means that you should always pay your bills on time, be sure to keep your revolving (credit card) debt respectable, and don’t shop excessively for credit.
Here's the longer answer:
Some of us have bad credit and need to improve it. Some of us have no credit and need to establish it. And, some of us have great credit and need to maintain it. Follow the the ten steps outlined below, and you'll be well on your way to better credit reports and higher credit scores:
Step 1: Find out what the credit report companies are saying about you.
The worst thing you can do with your credit is to ignore it or avoid it. It’s like trying to put a roof on a house that has no framing; it’s simply not going to work. So, the purpose of following this first step is to find out everything there is to know about your credit reports and scores. Then you can build your action plan for the future.
You can find out this information by getting copies of free annual credit reports directly from the credit reporting agencies. The website Annualcreditreport.com allows you to request a free credit report from each bureau every twelve months. These free annual credit reports does not include your credit scores for free, but that’s okay. It's better to verify that the information in your reports is up to date and accurate before purchasing your scores. Remember: Your credit scores are only as accurate as the information in your credit reports.
Note: Checking your own credit data online will not harm your credit scores. This is a very common misconception. The credit-damaging “hard inquiries” only occur when a lender or creditor checks your credit for the purpose of processing a credit application. You can check your own credit as often as you would like without harming your credit scores.
Step 2: Review your credit reports for accuracy.
Everyone should do this at least once every few months. This step isn’t going to be as easy as it should be. Credit reports can be confusing, especially if you aren’t used to reviewing yours. They can be dozens of pages long and contain unfamiliar codes and terms. But recent enhancements to online consumer credit report formats have made it a bit easier to sort through your data. Once you have your report, you will need to do the following:
- Identify your accounts – You should first check that the accounts listed on your credit report do in fact belong to you. Because they deal with huge amounts of data, the credit bureaus can accidentally mix or confuse your credit data with someone else’s. Note that some accounts are reported using a different name than what is printed on the card. For example, if you have a Home Depot credit card, it will show up on your credit reports as a Citibank credit card because Citibank is the issuer. You also want to be sure that nobody has opened accounts in your name without your knowledge. If you see any strange or unauthorized accounts on your credit reports, you can file a dispute with the credit bureaus to have them removed.
Step 3: Focus on the last 24 months.
- Be sure that all of the information is accurate – This applies to both bad and good credit information, but more so for the bad items (should you have any). Bad information, such as late payments, public record items, or collections, will drive down your credit scores. Therefore, you want to be sure that the information reported corresponds to your accounts. Inaccurate addresses, names, employers, positive payment histories, credit card limits, and dates are problems and need to be corrected even if they aren’t hurting your credit scores.
If you have bad credit, it’s very likely that you have negative information on your credit reports. Such information could include late payments, collections, tax liens, judgments, repossessions, foreclosures, settlements, and even bankruptcy. All of these things will hurt your credit scores.
Credit scores are calculated by applying a complex mathematical formula to almost all of the data on your credit reports. Credit scores pay special attention to the negative records that have occurred in the recent past, specifically things that were reported in the past 12 to 24 months. Since these are considered to be “recent” negative items, they will have a more drastic impact than items that are much older.
What this means to you is that you can start improving your credit if you make it a priority to stop doing things that continue to cause these negative items to be reported on your credit reports. Sure, you'll pay the price as long as the negative items are in your files, but they do lose their negative impact the older they get, as long as you don’t cause newly reported bad information to appear.
Step 4: Focus on the next 24 months.
Credit scoring models love to see positive information on your credit reports, especially if you have low credit scores. Therefore, if you have low scores, one of the best ways to improve them is to give the scoring model something else to focus on – a positive distraction. In the case of bad credit, you absolutely need to manage your money better, cleaner, and more responsibly than ever before.
It may even take opening a few new accounts for the specific purpose of paying them on time and managing them responsibly in order to start improving your credit scores. Remember: What happened in the past 12 to 24 months is very important to your scores. If you can show responsible credit management for the next 12 to 24 months, eventually that will become the past 12 to 24 months and the credit scoring models will reward you because of it.
Step 5: Understand your credit standing.
There’s a reason why your credit scores are what they are. It’s not an accident that your scores are good, average, or bad. One key to improving your credit is to have an understanding of what is impacting your credit scores. Many online credit scores (FICO especially) include a brief analysis of the factors that are causing your credit scores to be higher or lower. These factors can help point you in the right direction. The new Credit Report Card will give you tips on the credit score areas that you need to improve.
Step 6: Understand what “counts” in your FICO scores, and how much.
One of the reasons that people are often so confused about their scores is that they don’t understand how much certain things count. Here's the breakdown:
Step 7: Don’t let your ego cost you.
- Your Payment History – This segment is worth 35% of your FICO score points and is the most important component. Paying your bills on time will help you boost your score in this category, while late payments and collection records will hurt your scores. However, it’s important that you notice that while this category is worth 35% of the points, 65% of your score is determined by other factors. This means that making all of your payments on time is not the only thing it takes to earn a great score.
- Your Debt – This section is worth 30% of your FICO score. All of your debt balances are factored into your score, but your credit card debt has the most impact. It is important to keep your debt balances low in relation to your credit limits (your "revolving utilization") in order to maximize your credit scores.
- How Long You’ve Had Credit – This category makes up 15% of the points in your score. This segment specifically measures how long you’ve had credit by looking at the “opened” dates on your accounts. The older your credit history, the more points you’re going to earn from this section.
- Your Variety of Accounts – This segment makes up 10% of the points in your score. In order to earn as many points out of this category as possible you need to have a diverse credit history. Diverse in this case means a little bit of many different types of accounts including credit cards, car loans, student loans, and mortgages. The only type of account that can be unhealthy for your credit scores is a finance company account.
- Your Efforts to Get New Credit – This final section also accounts for 10% of the points in your scores. When you apply for new credit, a ”hard inquiry” is posted to your credit file by the lender you applied with. Having too many inquiries means that you are shopping excessively for credit and this can lower your scores.
This step is specifically for people who have FICO scores higher than 750. First off, congratulations on your great scores. The bottom line is that with a score of 750 lenders see you as golden and you’re likely to get their best offers.
You'd be surprised at how many people think that a score of 750 needs improvement. There’s no need to try and improve your 750, but there is a need to maintain it. In fact, you’re more likely to lower your great scores by trying unproven, unwise, and unnecessary strategies than you are to improve them, and that’s the last thing we want to happen. Think about it this way: It’s a whole lot easier to lower a 750 than it is to improve it. So, be happy and enjoy your excellent scores. Focus on what it takes to maintain them rather than improve them.
Step 8: No knee-jerk reactions.
If during Step 1 you realize that things aren’t exactly how you wanted (or expected) them to be, don’t panic. The worst thing you can do is start closing accounts or opening accounts or transferring balances just because you think it’s the right thing to do. In most cases, it's best to proceed with caution. And be very careful with the advice you get during your credit journey. The majority of people are misinformed about credit reporting or credit scoring. The worst thing you can do is get yourself into a deeper hole by listening to someone who isn’t giving you good advice.
Step 9: Avoid credit repair scams.
There is an entire industry of scam artists out there preying on people with bad credit. These so-called credit repair companies offer services promising to clean up the negative information on your credit reports. Fees range anywhere from $39 to hundreds of dollars per month. Essentially all these companies do is send dispute letters to the credit bureaus disputing negative (but accurate) credit information on your credit reports. Save your money and avoid these expensive, ineffective, and often illegal programs.
Step 10: Be realistic about negative credit information.
There is no quick, easy, or inexpensive way to rebuild your credit. If you have negative records such as collection accounts, judgments, bankruptcy filings, or liens, there is often not much you can do about those records while you wait for them to expire after seven to ten years. That certainly doesn’t mean that you can’t get credit, but lenders will be cautious about lending you money or giving you one of their credit cards. And those that do choose to do credit-related business with you will treat you like a high-risk borrower. That means higher interest rates and fees, as well as lower credit limits…and in some cases, decline letters.
Next, you’re going to probably have to endure some secured credit cards for a while. This type of credit card is actually a great way to rebuild your credit. You give a lender a cash deposit and the lender issues you a credit card secured with a credit limit of the same amount. If you default on your account, the creditor has a safety net of collateral to fall back on. Secured credit card issuers charge fees and have very high interest rates. That’s their way of making money when doing business with a high-risk consumer. You don’t want to do business with them forever, but they are a good place to re-start your credit history.
And lastly, if you are thinking of buying a house or a car or anything else that’s expensive, really think hard before you do it. Paying 15% on a home loan is painful, just like paying 29% on a car loan is painful. We all need a way to get around and we also need a place to sleep, but as soon as your scores improve to, say, the mid 600s, you should think about refinancing and getting out of those ridiculous interest rates.
After several years (not twelve months), your credit scores should have improved enough that you can re-enter the world of “prime” borrowing. That’s assuming that you’ve rebuilt your credit reports and credit scores by establishing new accounts and managing them responsibly this time around.