Understanding Building and Improving Your Credit Scores

Credit scores are a vital part of our financial lives. They are used in loans, credit card applications, mortgages and more. Landlords, employers and insurance companies also use them.

Understanding what makes up your credit score can help you improve it. Here are some key factors: payment history; credit utilization (how much you owe versus the amount of available credit); length of credit history; and new credit.

Pay Your Bills on Time

Your credit score is an important factor for lenders and other potential creditors, such as cellphone providers or landlords. It also helps influence the interest rate you might pay or the approval process for loans, mortgages and credit cards. Lenders and service providers want to know that you will be able to pay them back on time.

Payment history accounts for 35% of your credit score, so one late payment can significantly harm your credit. You can minimize the impact of missed payments by making sure you always pay your bills on or before the due date, no matter if they’re automatic or not.

A great way to do this is to create a list of all your recurring or bill-payment obligations, such as rent, utilities and cell phone plans, and use a calendar or budgeting app to mark due dates and ensure payments are made on time. This will help you avoid costly penalties, interruptions to service and damage to your credit score.

Don’t Apply for New Credit

If you apply for multiple credit cards in a short period of time, it can affect your credit score because the credit scoring model looks at your “new credit” factor, which accounts for 10% of your credit score. This factor includes the total amount of credit you use, known as your “utilization” ratio, as well as how many different types of accounts you have (credit card, auto loan and mortgage).

When you apply for new credit, lenders usually run a hard inquiry on your credit report to see if you qualify. These inquiries may lower your score by a few points, but the impact could be greater if you have several hard inquiries within a short period of time.

The nation’s three biggest credit-reporting agencies announced this week that they would standardize their credit scores in an effort to make them easier for lenders and borrowers alike to understand. However, consumer advocates worry that the move is simply a challenge to the dominant FICO credit-scoring system.

Don’t Use Too Much of Your Available Credit

Credit utilization, or the percentage of your available credit that you use, has a big impact on scores. Experts recommend keeping your credit utilization below 30% to maintain a good or excellent score.

Opening many new credit cards in a short period of time might have a negative effect on your credit score. This can happen even if you don’t make any new purchases.

A better strategy might be to ask your card issuer to raise your credit limit, as long as you don’t max out that extra “room.” Credit score modeling gives weight to the age of credit, so having a older average will help.

It may also be beneficial to spread charges across multiple cards rather than putting all of your debt on one card. This will keep your credit utilization ratio low while showing lenders that you can manage multiple accounts and balances. A good or excellent credit score is important for borrowing money, renting an apartment, getting insurance, and many other day-to-day financial activities.

Keep Your Old Credit Lines Open

The length of your credit history and the average age of your accounts account for 15% of your score. Closing old cards can reduce your credit history’s overall average, which in turn will decrease your score.

Another reason to keep older cards open is that it can help lower your credit utilization, a key factor in your score. Creditors look at how much of your available credit you use and prefer to see that number below 30%. Keeping your card active with a small recurring charge can help you stay below this threshold.

Finally, keeping your unused card open can increase your overall credit limit, which is a positive factor in your credit. This can also help improve your credit score if you are looking to apply for new credit soon. Lenders often perform a hard inquiry on your credit report when you request new credit, so keeping your card(s) open will help prevent them from lowering your score prior to approval.

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