Many people, especially young professionals, wonder how to improve their credit score. Unfortunately, not many understand the importance of it — or, in reality, what it may even mean. We’re here to help with that.
Managing your credit score should be a lifelong process because your credit use and needs change each year. If you’re reactive, credit management can be time-consuming. If done incorrectly, it can cost you tens of thousands of dollars over the course of your lifetime.
The good news is, with this seven-step method, you can easily stay on top of your credit score, keep your scores high, and get the best deals on mortgages, car loans and credit cards your whole life.
The first step to building, repairing, improving or managing your credit is to pull your three credit reports. Three companies, Equifax, Experian and TransUnion, collect financial data about you and sell it to lenders.
Lenders use these reports to decide whether or not to give you a loan or credit card, how much credit to give you and what interest rate to charge you.
Scoring companies use these reports, which are updated each time you use credit, to issue you credit scores. The two main scoring companies are FICO and VantageScore. These and other companies give you a main score, as well as dozens of other scores for use by car dealers, banks, mortgage companies and other lenders.
If you have negative statements on your credit reports, this makes you less creditworthy. That’s why it’s important to know what’s on your credit reports.
You can get a free copy of each of your three credit reports each year under federal law. You can visit AnnualCreditReport.org to get all three reports at once, or visit the websites of Equifax, Experian and TransUnion and request your report from each bureau.
Your free credit reports do not include your credit scores. You can get your scores free, through methods like credit card account. Or you can sign up for a credit monitoring service.
If you spot any errors on your credit reports, fix them immediately. Errors might be as simple as an incorrect address, or be more serious, such as showing that you have a debt that’s in collection.
Sometimes, you will see an error on only one or two of your reports.
The quickest way to fix an error is to contact the lender who provided the incorrect information to the reporting bureaus. If that lender agrees that it made a mistake, it will contact the bureaus and correct the mistake. The bureaus will then update your report without going through an investigation.
You can also start the correction process by contacting the bureau that has the mistake on your report. Just follow the directions on the company’s website for starting a dispute.
The bureau will then contact the lender with your challenge. If the lender agrees, the incorrect information is removed. If the lender disagrees with you, the bureau decides who is right. This process can take more than a month and the credit bureau might side with the lender.
At that point, you can add a note to your credit report so any lender who sees it reads your side of the story. This usually doesn’t help much because lenders prefer to use numbers, not stories. But it can’t hurt to add an explanation (not an excuse).
You can also take legal action against both the lender who provides the information you believe is incorrect and the credit bureau for including it.
Now that you’ve cleaned up your credit reports (or while you’re working on that), take a look at your debt.
List your debt, including credit cards, student loans, vehicle loan, mortgage or other debt.
Rank your debt from highest interest rate to lowest to determine what debts you want to start paying down first.
Check your credit cards to see which ones offer a 0-percent or low-interest promotional rate. This can save you hundreds of dollars in interest payments during the term of the balance transfer promotion.
You can often decrease your interest rates on multiple credit products by doing a debt consolidation. However, lenders don’t like consolidations, which get reported on your three credit reports, and they can significantly hurt your credit scores.
Lenders don’t like consolidations because you sell your debt to a third party who gives you a lower interest rate, with the third party then negotiating even lower interest rates on your original debt. These third-party consolidators use hardball tactics that cause your original lenders to have to take less.
Once you’ve reviewed and addressed any problems with your credit reports, it’s time to start raising your credit score.
The quickest way to do that for most people is reduce your debt. Have old items in your closet, garage or attic you can sell? Hold a yard sale or sell items on Craigslist or EBay to raise quick money and pay down debt.
Depending on your relationship with family members, you might offer to pay them 5 or 10 percent on a loan you then use to pay down credit card debt that’s at 20 percent. You eliminate 10 percent interest on your debt and they get interest they couldn’t earn with a checking or savings account or CD.
Another way to improve your score is to improve you debt-to-credit ratio. This is different than simply lowering your debt.
One way lenders evaluate you is to look at how much of your available debt you’ve used. For example, if you have $10,000 worth of credit available with your cards and you’ve made $9,000 worth of charges, you’ve used 90 percent of your credit. That’s not good.
You want to keep your credit usage around 25 percent, if possible, to optimize your scores. However, lowering your credit ratio from 90 percent to 80 percent still helps.
One way to do this is to open a new credit card account. If you get a $5,000 line of credit, you’ve now used $9,000 of your $15,000 available credit, or only 60% of your available credit.
Opening a new card also lowers your score, but depending on how much you lower your credit use ratio, you might come out ahead.
If you open a new card that offers a low- or no-interest balance transfer during a promotional period, take advantage of that. You’ll keep your debt lower with a low-interest balance transfer by eliminating those interest amounts added to you debt each month.
Be careful shopping for cards. If you authorize a credit card company to look at your credit reports, known as a hard pull of your reports, you’ll lower your score. If you open a new card, you might find they only gave you a $500 line of credit. If you then close that card, that hurts your score.
Don’t close existing credit cards if you’re not using them. Closing a card negatively changes your credit ratio. You also get more points on your score when you have older cards.
Finally, don’t pay off installment loans early if you need to boost your credit score. Installment debt is debt you pay off at a fixe rate each month, like a vehicle or student loan. Lenders see installment loans as a sign that other lenders trust you, and this raises your score.
If you’re thinking about paying down an installment loan early, look at how much interest you’ll save by doing that. Then look at how much interest you’ll save by having a higher credit score to use for other credit needs.
After you’ve analyzed your debt, decide how you’re going to start paying it down.
Some financial gurus recommend that you pay off the smallest amounts first to get a psychological boost that motivates you to keep working on debt reduction. You’ll save more money if you eliminate accounts with the highest interest rates first.
Be careful about paying off your mortgage early. Where else are you going to get a loan for 5 percent or less? You’ll probably earn more than that putting your money into an investment product or your company 401(k), especially if your company has a match.
The best way to create a debt-reduction plan is to create a personal budget. This will often help you identify spending you can cut and let you apply those cash savings to reducing current debt and avoid increasing debt.
Make sure you have the best possible credit cards, in terms of
Don’t pay 20 percent interest if you can get a card at 10 percent. Also, be aware that many cards don’t require annual fees of $50 or more.
Look for cards that offer balance transfers, which can save you hundreds of dollars in reduced interest payments.
Find cards that offer cash back, free airline miles or rewards points you can use on hotels, dining, gas and other spending.
Shopping for cards doesn’t mean applying for cards. As we stated previously, each time you apply for a new card, the lender will do a hard pull of your credit report. Comparing cards online won’t hurt you. Only apply for a new card if the benefits will save you hundreds or thousands of dollars in reduced interest payments.
If you open a new card, transfer the balance from one of your other cards with a higher interest rate, then keep that older card to keep your score higher. Just don’t use the old card.
After you open a new card, set up autopay to make sure you don’t miss a payment, which can trigger higher interest rates, penalty fees and the loss of your balance transfer promotional rate.
After you’ve taken the steps to improve your credit, maintain your creditworthiness by monitoring your credit reports and scores and pulling your free credit reports annually.
Check to see if any of your credit cards or loans comes with a free monthly credit score, then sign up for a credit monitoring service after you’ve done some homework to find out which ones are legit. This will let you check your reports and scores on a regular basis.
All images via Pexel
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