As I explained in Sensible Financial®‘s Winter newsletter, your FICO® credit scores influence what credit is available to you and under what terms. Derived directly from each of your credit reports at the three leading credit bureaus (Equifax, Experian, and TransUnion), your FICO® scores summarize your credit risk for lenders who are considering offering you products or services on credit, or are considering granting you a loan. (They are also used by landlords and employers to determine whether or not they should offer you an apartment or a job.) Simply put, the higher your credit score, the more likely you will be granted credit, the more credit you will be granted, and the better the terms are likely to be. Over one’s lifetime, there could be considerable savings from having high credit scores. So, here are some TIPS for improving your FICO® scores.
Credit bureaus determine your FICO® score using five criteria, each with its respective percentage weighting, as follows:1
Payment history (35%)
Your payment history is the most influential criterion. How consistent are you at paying at least the minimum payments on time? One late payment will probably be overlooked, especially if it is less than 30 days overdue. However, if you show a history of late or missed payments, this will significantly affect your score. And in the case of credit cards, your interest rates will likely skyrocket.
- • Tip: Be sure to pay at least the minimum balances for all your debt on time at each pay cycle.
• Tip: In the case of mortgage, auto, and student loan payments, set them up for auto-pay directly from your bank account. That way, you will never pay late or forget to make a payment.
• Tip: Although maintaining a running balance on credit cards might not, by itself, reduce your credit score (as long as you pay the minimum on time each month), it is best to pay the balances in full each month, since the interest rates tend to be high, even for people with excellent credit scores.
Amounts owed (30%)
How much do you use credit (a.k.a. credit utilization) compared to the amount of credit available to you? This is especially relevant with revolving credit, such as credit or store cards. In general, the higher the credit utilization-to-available-credit ratio, the lower your score. If the ratio is very high, this can be an indication that you are overextended on credit and are more likely to make late payments or default on your debts. A larger number of accounts with outstanding balances can also indicate that you are overextended and could impact your score. (Ironically, people with no credit history and who have no credit cards tend to be viewed as a higher risk than people who have credit card debt but have a track record of making on-time payments.)
• Tip: Keep the balances on your revolving debt (credit and store cards) low.
• Tip: Don’t open new credit cards just to increase your available credit. This could actually reduce your score. (See “New Credit” below)
• Tip: Realize that if you close revolving credit accounts, this will lower your total available credit (i.e., increase the utilization-to-available-credit ratio), which could reduce your score somewhat. However, this would likely be a short-term, low-impact reduction. If you tend to over-spend, the long-term benefit of closing non-essential accounts would likely offset any temporary downward blip in your FICO® score.
Length of credit history (15%)
How long have you had your credit accounts, and how long has it been since you last used them? Late payments or over-extendedness notwithstanding, the longer your credit history, the higher your score.
• Tip: Unfortunately, you cannot speed up time. The highest scoring in this category is achieved from decades of credit history, not months or years. If you are relatively new to establishing credit, slow and steady is the way to go. Use your accounts if needed, keep the balances manageable, and make sure you pay on time. The good news is that even people with relatively short credit histories can have decent credit scores if they use credit responsibly.
• Tip: If you have too many revolving credit accounts and are thinking of closing some, think twice before closing the oldest accounts, as this could have an adverse effect on your credit score.
New credit (10%)
Have you recently opened new credit accounts, and if so, how many did you open, and how high are the credit limits? Credit bureaus record every inquiry associated with a revolving credit application. If you have opened multiple credit card or store card accounts in a relatively short period of time, this could reduce your credit score. However, as long as you have a sufficient credit history, one or two additional inquiries shouldn’t reduce your score that much.
Unsolicited inquiries made by companies against your credit report(s) for the purpose of promoting offers of credit or pre-approving you for certain products and services are not counted in determining your credit score.
- • Tip: Keep the number of credit cards you own relatively low. Two or three tops if possible. Resist the temptation to open up a new credit or store card just because you are offered frequent flyer miles, one-time discounts on purchases, or other incentives.
• Tip: Multiple auto or mortgage inquiries in a relatively short period of time are generally treated as one inquiry, simply because people often “shop around” before choosing this type of debt. “Relatively short period” depends on which version of the scoring technology each credit bureau is using, but it generally ranges from 30 to 45 days. So, if you are going to apply for these types of loans, apply for all loans within 30 days rather than over, say, a two-month period.
- • Tip: Requesting your own credit report or credit score from each of the three credit bureaus will not adversely affect your score.
Credit mix (10%)
Which types of credit accounts (mortgage, retail, auto loans, etc.) do you have, and in what proportion do you use them? This criterion won’t be a key factor unless there is nothing else upon which to determine your credit score.
• Tip: Apply for new accounts only if you really need them, not to have a better mix of credit.
- • Tip: If you have a short credit history, opening a credit card account and using it regularly can help raise your credit score, as long as you use it responsibly.
Factors such as age, race, place of residence, marital status, and earnings are not factored into your FICO® scores because either they have not been proven to be predictive of your credit worthiness, or companies are prohibited by law from using them
What to do if there are inaccuracies in your credit reports
As stated above, each of the major credit bureaus develops a FICO® score for you. They must be accurate and fair in how they present information in your credit reports. However, the burden is on you to contact the agencies and identify and substantiate the errors when they occur.2 Inaccuracies can occur for a number of reasons. Perhaps the most obvious reason is that creditors can make mistakes or act unfairly when reporting your payment history. Second, even if a creditor reports the information accurately, it could be unfairly recorded by the credit bureau. For example, if you paid down a loan as agreed, but your loan was sold multiple times to different lending institutions during the life of the loan (mortgages are notorious for this), there might be several entries on your credit report that are mistaken by the credit bureaus as separate and distinct loans. This could negatively affect your credit score. Third, inaccuracies can occur due to a divorce. If your ex-spouse was responsible for repaying a certain loan as part of a divorce decree, but he or she missed the payments, this may appear (unfairly) on your credit report.
When situations like these occur, it is important that you contact the credit bureaus to dispute the inaccuracies. (You can file a “dispute” on the credit bureau’s web site.) Your written correspondence should be clear and concise and include supporting documentation where possible. Since not all creditors use all three credit bureaus, the errors might not exist on all of your credit reports. You will need to identify which errors exists on each credit report and contact the respective bureaus separately. If the errors are numerous and complex, you might consider hiring a reputable credit repair service (especially if you have been the victim of identity theft). However, beware of services that promise you the moon. You should run for the nearest exit if a company demands full payment up front or promises you a specific credit score in a specific timeframe if you hire them.
Your FICO® scores are important measurements that creditors use to determine your eligibility for credit and the terms under which they will offer it. A relatively high score can give you access to the best credit terms available and can potentially save you tens if not hundreds of thousands of dollars over your lifetime. Because mistakes on your credit reports at the three major credit reporting bureaus can adversely affect your scores, it is important that you correct these errors as soon as you discover them, and especially before applying for new credit.
The FICO® score need not be mysterious if you understand how it works and how your account and payment behavior affect it. It is important to keep the five scoring criteria in proper perspective. By far, the two criteria that most influence your score are your payment history and the amounts you owe (credit utilization). If you pay your debts on time and don’t over-extend yourself on credit, you probably don’t need to worry too much about your credit score (although you should still check it once in a while). Your history of opening and closing accounts, as well as the credit mix, exert comparatively less influence on your score, and even if they do negatively affect it at times, the change is usually small, and the score can bounce back relatively soon. As far as length of payment history goes, this is mostly a function of your age, which is out of your control.
To find out your FICO® scores for free, go to www.credit.com or www.creditsesame.com.