I have recently been putting my thoughts about credit down on paper while writing financial education curriculum for a local non-profit so I thought I’d share my top 4 practical ways to improve your credit score.
Before getting in to my tips, I want to share why I think building credit is important. If you already know credit is important, feel free to skip this section. Your credit score is used in various ways to measure how responsible you have been with money in the past. And your score can be used to predict how well you are likely to handle your finances in the future. It’s essentially your reputation as a borrower. If you have a bad reputation or haven’t borrowed much before and have no reputation at all, you are a risk to businesses that could lend you money. These tips help you improve that reputation (your credit score) — I’ll discuss in future blog posts exactly how that can result in lower interest rates which make borrowing less expensive and will save you money. It’s also important to point out that, in addition to traditional borrowing (financing a car, buying a house, or getting a credit card), your credit score can affect getting approved to borrow money for a new phone or furniture, your trustworthiness to a landlord when applying to rent an apartment, and even highlight your responsibility for employers considering you for a new job or promotion.
Now, keep in mind the tips that would work best for someone just starting out with credit may be very different compared to the tips that work best for someone who has a lot of debt or had issues in the past. I’m able to separately consider those things when working individually with a client on a personal level — I’ll do my best to make those sorts of distinctions for this blog.
Tip #1: Figure out a system that works for you to pay your bills on time
The most important factor for your credit score is on-time payments. There’s not much that will cause your credit score to drop faster than a missed payment you forgot to pay. To solve this issue, you need to have a routine that helps you pay all of your bills on time. One popular option is making automatic payments — just make sure the amount will cover the minimum due. For me, however, I prefer to have the control and I choose to pay my bills manually each month. Two different approaches I’ve used to make sure I don’t forget payment are 1) to use a spreadsheet to record every time I pay a bill (or it shows I haven’t paid it yet) and 2) choose to receive paper bills in the mail and have them in a stack on my table ordered by due date.
Tip #2: Work to keep credit card balances down
Lenders don’t really want you to spend up to your maximum credit limit. If you are close to maxing out your credit cards, lenders get nervous that you may be overextended and drowning in debt. To show you’re not a high risk borrower, paydown or keep your balances so you’re using less than 30% of your limit. [The math is Balance Owed divided by Credit Limit times 100. So for example, a balance of $2000 on a card with a $12,000 limit is 16.6% of the limit]. This is one of those areas that is much easier if you learn this lesson early on and never get to that point and much harder a situation to get out of when you have a lot of debt. If you are just starting out with credit, if you can pay your credit card off each month after a balance reflects on your statement you will build your credit score and can pay zero interest. If you have lots of debt, credit utilization percentage is probably not the highest priority for you right now — you’d likely be better off by taking inventory of all of your debt and deciding how to strategically reduce what you owe to make the most impactful progress.
Tip #3: Keep your accounts open and active
How long your credit accounts have been open matters. Don’t close credit cards after you have them paid off, especially if it’s one of your oldest accounts. Charge something periodically on each of your cards to keep your accounts active and in good standing. Lenders will slash your credit limit or close your account altogether if you aren’t using it periodically.
Tip #4: Mix it up a little
For your credit score, it’s best to have a good mix of credit cards and installment loans like auto loans, student loans, and mortgage loans. Credit cards show lenders you have self control to limit overspending and you’re able to budget lower payment amounts some months and higher payments other months. Loans show that you can handle steady fixed payment amounts every month for the entire loan term. If you only have ever had credit cards, consider using a small auto loan with your next car purchase or look in to credit builder loans offered by some credit unions to add to your mix of credit types.
For other tips, check out this article in the Penny Hoarder that I recently contributed to called titled “9 Secret Habits of People With Credit Scores Above 800“.