How Credit Scores Work and Ways to Improve Yours

How Credit Scores Work and Ways to Improve Yours

As credit has become more easily available in our society, your credit report, and subsequently your credit rating, has become more important in your every day life. Your credit rating affects all aspects of your finances when it comes to borrowing money, especially when it concerns real estate.

Your credit report itself is simply a listing of all of your mortgage and consumer debt. The three main credit reporting agencies are Experian, Trans Union and Equifax. Every time you take out a loan, make a loan payment or credit card payment, the lender who extended that line of credit to you will update your payment history with these agencies. In addition to credit information, you will also find listed any liens and judgments on your credit report as well as all of your previous addresses and places of employment. The total all of this information makes up your credit report.

Your credit score is a calculated number which gives people an idea of your lending risk. Credit scores range from 300 to 900, the higher your credit score the better. The mortgage products and interest rates that you will qualify for are most often determined by how high or low your credit score is. One thing that many people do not know is you have the legal right to obtain a copy of your credit report.

Here’s How Your Credit Report Score is Determined:

• 35% is determined by your payment history. Do you regularly pay your bills on time to any creditor that submits your information to the credit bureau? Overdue medical bills, utility bills and other bills may appear here as well as liens or judgments against you.
• 30% is based on the total amounts you owe each of your creditors compared to the total credit available to you or the total loan amount you took out (debt to equity ratio). If you’re maxing out your credit cards, your score may suffer. Ideally you want to keep your balances below 30% of your maximum credit line.
• 15% is based on the length of your credit history, both how long you’ve had each account and how long it’s been since you had any activity on those accounts. The fewer and older the accounts, the better (assuming you’ve made timely payments).
• 10% is based on how many new accounts you’ve recently opened compared with the total number of your accounts, as well as the number of recent inquiries on your report made by lenders to whom you’ve applied for credit. Your score can drop significantly if it looks like you are out shopping for as many lines of credit as you can find. Many lenders consider this a sign that you might be in financial trouble.
• 10% – The different types of loans you have determines the final 10%. If you have installment debt like a mortgage where you pay a fixed amount each month then this shows a potential new lender you can manage a large loan. But how you pay off revolving debt, like credit cards, tends to carry more weight since it’s seen as more predictive indicator of your behavior. (Do you pay off the balance each month? Just pay the absolute minimum? Charge your cards to their maximum limits? or rarely use them)

The good news is that your credit report is flexible document and you can make changes to it over time that will bring your score up and increase your lending choices.

Following are five steps you can use to help attain a speedy credit score boost:

1. Pay down credit cards. The number one way to increase your credit score is to pay down your credit cards to below 30% of your maximum limits. Revolving credit like credit cards seems to have a more significant impact on credit scores than car loans, lines of credit, and so on.
2. Limit the use of credit cards. Racking up a large amount on your credit cards and then paying it off in monthly installments can hurt your credit score. If there is a balance at the end of the month, this affects your score – credit formulas don’t take into account the fact that you may have paid the balance off the next month.
3. Check credit limits. Make sure your lender is timely reporting all of your monthly transactions because this can have a significant impact on how other lenders see your file. Make sure all of the information is up to date and any bills you have paid off or accounts you have closed are showing accordingly. Also some lenders do not report your correct maximum credit limits. This means the credit bureau can not determine if your current balance is below 30% of the limit. If you are regularly charging the same amounts on the card each month (example between $500 and $1000) then it may look to the credit bureaus like you are consistently maxing out your limits and they will penalize you.
4. Keep old cards. Older credit is better credit. If you stop using older credit cards, the issuers may stop updating your accounts. This means the cards can lose their weight in the credit formula and, therefore, may not be as valuable in improving your credit score even though you may have had the cards for a long time. You should use these cards periodically and then pay them off.
5. Don’t let mistakes build up. You should always dispute any mistakes or situations that may harm your score. If, for instance, a phone bill is incorrect or an account that is not yours is showing on your credit report, you should instantly dispute this, make the credit bureau aware of the mistake, and have them correct it.