It's difficult to appreciate how important credit is until you actually need it for something. At least that was my experience.
After I applied for my first mortgage and saw the interest rates lenders were offering me, it was then I realized I should probably pay a lot more attention to it.
Good credit can be a useful tool in obtaining the things you want in life - whether it be a new home or money to start a new business. And since you’re here, I’m guessing there’s a good chance you’ll be looking to borrow some money at some point in the future.
To prepare you for that moment, I’ve jotted down the most important factors in raising your score, along with some habits I’ve created to work them into my routine.
1. Pay Your Bills On Time
This may seem obvious to most, but you’d be surprised by the amount of people who have garnered a relationship with the words “past due.”
Consistent on-time payments are the most important factor in raising your score according to FICO. This is especially true when they are made on your outstanding debt. Things like school loans and car notes appear on your credit report as soon as the money is lent to you, so paying them down on their due dates (or earlier) is a good look when lenders run your credit.
Making payments on bills not associated with debt (e.g. utility bills or rent) won’t have an effect on raising your score. That’s because they are not reported to credit bureaus (that is, if you’re paying them on time). Missing a payment on one of these, however, can force it into collections and that will show on your report for up to 7 years. On top of that, you can expect to see a drop in your score of 100 points or more.
What I Do
Simply put, I pay my bills on time.
However, this may not be as easy as it sounds, especially if you have some trouble managing your money. If you need some help prioritizing where your dollars go, have a look at Don't Budge on Your Budget: Creating a Budget That Works for You.
2. Keep Track of Your Credit Card Utilization
Here’s something that you may not be aware of, but is crucial to the health of your credit score. Credit card utilization is a measurement of how much of your credit you are using and is calculated by taking the total balance you owe at the end of a cycle and dividing it by your credit limit.
For those of you who are more visual learners like myself, I’ve included a chart below to show how utilization would be calculated under two different scenarios:
WalletHub recommends keeping your utilization between 1-9% to improve your score the fastest, but usually anything below 30% won’t be too concerning to lenders.
And just so you’re aware, your utilization is calculated based on the usage and limits of all your credit cards.
What I Do
At the end of each credit card cycle, I like to leave an ending balance of $2.
This is done for two reasons: it’s on the lowest end of the optimal utilization range and my credit card (American Express) writes off any balance below $2.
What I’ve run into is that paying down my card balance to $0 actually stunts or even hurts my score (drops by about 25 points). I later discovered having no ending balance, and therefore a 0% utilization, gives the impression you are not using your credit (remember, your utilization is based off of your ending balance).
If lenders can’t determine how you’re using your credit, it makes it hard for them to predict how responsible you’ll be with their money.
This goes along with why I leave $2 on my card. If I were to leave $1 on my card, Amex would wipe out that amount and I’d have no ending balance on my card, giving me a 0% utilization for the cycle.
I’ve fallen victim to this a couple of times, but usually my score bounces back after 1 or 2 cycles. Be sure to check what amounts your credit card companies are writing off (if any) before making this mistake.
3. Pay a Little Extra When You Can
I know we all dream of the day when our debts are no longer with us, but when it comes to your credit score, the longer they hang around the better. That’s because part of the algorithm in calculating your score is age of credit.
Lenders love to see that someone can consistently make payments over long periods of time. You will see your score grow as the balances continue to decrease. Paying a little extra will give you even more of a boost than just paying the bare minimum.
Just so we are clear, this is only referring to paying off loans you pay over time (usually years). When it comes to paying off your credit card balance, it’s best you take care of that before your next cycle ends to avoid the double digit interest rates.
What I do
Fortunately, I’m in a position where I can throw in a few extra dollars towards my outstanding loans, and I’ve been able to reap the benefits of it with a credit score that my parents are quite proud of (and sometimes even jealous of).
In reality though, the consequence of paying off a loan early isn’t the worst thing to ever happen. Yes, I’ve seen my score drop a few points after paying off some college loans in full (decrease of 5-8 points), but the bounce back was pretty quick.
In some cases it may be to your benefit to just go ahead and clear an outstanding debt, especially if the interest rate is high. Personally, I'd have no problem trading in a few extra points so that I can keep more of my money.
4. Limit Hard Inquiries
Know anyone who has a credit card for every day of the week? If so, please share this article with them as soon as you’re done reading. Chances are, their score has taken a dip due to a bunch of hard inquiries on their credit report.
Hard inquiries occur when you give a lender permission to check your credit history when applying for a loan. When you are looking to obtain a mortgage, car loan or new credit card, the lender will perform a hard inquiry. These stick around on your credit report for 2 years.
After one occurs, you’ll usually see a drop in your credit score by a few points, but nothing that will knock you off your feet. And the good thing is when you’re looking for the best rates, multiple hard inquiries for the same purpose within a short period of time (30 days) will have the same effect as one hard inquiry. So feel free to shop around with multiple lenders when you’re ready to make a big purchase.
On the contrary, a soft inquiry occurs when you are checking your own credit report or giving an employer permission to check your credit history for a background check. One also happens when lenders pre-approve you for offers on loans and credit cards. When you receive that credit card in the mail out of the blue, the company has performed a soft inquiry on your credit.
Soft inquiries do not affect your score and you can check your report to see who has done one on you.
What I do
I like to limit hard inquiries to one per year, usually for the purpose of looking for an investment property. If you’re looking to keep your score as high as possible, it’s best to keep no more than two on your credit report at a time.
Take Action to Boost Your Credit Score:
Create a budget that prioritizes paying your bills on time.
To really boost your score, make sure your credit card’s ending balance is 9% or less of your spending limit, but never pay it down to $0.
If you have some extra funds from your paycheck, consider using them to pay down your loans faster.
Don’t open a bunch of new credit lines in a short period of time. Too many hard inquiries on your credit report can have a negative impact to your score and be a red flag to lenders.
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