Money Mondays: Improving Your Credit Score

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  • How can I improve my FICO score? What is a FICO score and what does it really measure?
    Great topic. We all basically know that a FICO score measures how creditworthy an individual is. The higher the score the better your credit—and the more likely you are to get loans and get better interest rates on those loans.  Lenders—banks, credit card companies, mortgage lenders—lean heavily on it when they are deciding whether or not to give you a loan. Scores range between 300 and 850.  Anything above 650 is good, but anything below 620 will make it difficult to receive money at a favorable interest rate. The average score, by the way, is 664.  

    Here are some things that go into your FICO score: your payment history, how much money you owe, how long you have been using credit, and the type of credit that you are using.  A FICO score accounts forall of these categories, not just one or two, so you really don’t want to neglect one area in hopes of substantially improving another one.

    How can I improve my credit score?
    Big picture: there’s usually no quick fix, so the best way to repair your credit score is to do it responsibly over time. Still, you can take a few simple steps to get you headed in the right direction.

    First, request a free copy of your credit report and check it for errors. You can do this by visiting www.annualcreditreport.com. You can get one credit report from each of the three major credit bureaus here. This site offers a credit report, not credit scores. If you want to know your FICO score, you can go to www.myfico.com. Now, checking your report for errors may seem basic, but sometimes there are mistakes, and you can improve your score by notifying the credit bureau and reporting agency of these errors.

    Once you know your score and decide to improve it, the best way to do so is to reduce debt. That almost always means paying down your credit card debt as aggressively as you can.  Move as quickly as you can toward having just one credit card, lower your usage of credit cards, and focus on reducing your debt level rather than attempting to spread it over multiple accounts—which in no way helps your credit rating and can actually hurt.  The FICO looks at the total amount of credit you have available and how much of it you use. The higher a percentage of your credit you use, the worse your score. Most experts recommend staying under 35%. People with average scores are in the 40% to 50% range.  As you might imagine, late payments are a big deal: A single late payment can drop your score by 50 to nearly 200 points, depending on where your score starts. 30 or 60 day late payments don't do lasting bad damage. But a  90-day late payment hurts your score for 7 years.

    Why would I want to focus so much on credit cards? My mortgage is the bigger number. Why not reduce that first?
    Here’s why: some types of debt are more costly than others.  It comes down to interest rates and taxation.  

    Interest rates are simple: you want to first eliminate the debt that charges the highest rate. Usually your highest interest rates will be credit cards, followed by car loans, then mortgages and student loans.  

    On the tax side, some debt has tax advantages, some doesn’t. Those loans that the government sees as broadly beneficial get tax breaks. Home ownership and education are seen as socially good things, so you get tax breaks on them. Most other kinds of debt—credit card debt and car loans, for instance, don’t offer such an advantage.  

    So credit card debt is a double-whammy: it usually has a high interest rate and offers no tax advantages. Mortgages and student loans are “good” debt:  they generally have lower interest rates and are tax-advantaged.

    Any other advice?
    Yes, once the big things are under control, a great way to incrementally improve your score is to set up payment reminders. Some banks offer payment reminders that you can receive either by email or text message. You may also want to consider enrolling in an automatic paying method if it is available, so that you do not fall behind on any bills. Auto-pay makes sure that payments are debited from your bank account on time.

     

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