Credit Score: How to improve credit score

What is Credit Score?

I don’t want you to see credit score as just three digit number assigned to you by the credit rating agencies. It is more than just a number. It has to do with your credit worthiness. And this is arrived at through the statistical analysis of your past credit information as contained in your credit file. Many lenders and businesses rely on credit score when it comes to assessing the creditworthiness of consumers in order to decide whether a person will pay bay his debt if granted credit. Credit score ranges between 300 and 850. Everybody will like to have a credit score of 850 as this is the highest ranking as far as credit rating is concerned. I remember when I was in school. If you asked any student what marks he would like to score in a particular subject, majority would say 100%. But this does not come very cheap. While the score might seem far-fetched, you would still found few brilliant students who would almost hit the mark. In most cases, they happened to be the quiet ones in the class. Though they may not make noise, their results usually spoke for them. So, anytime we had new teachers, they soon became the teachers’ favourite students.

In the same way, lenders may not know you if you approach them for a loan but your credit score can speak for you. It can make a difference whether you will be granted a loan or not. No lenders will just give you loan simply because you promise them that you will pay back the loan as at when due. However, they still need to lend money to people in order for them to make money. If they lend money to somebody who will not pay back, they will not only lose interest income; they will also lose their capital. This means that they need to be careful so that they don’t lend money to people who will likely default in payment. For this reason, lenders will like to limit their risks by assessing your creditworthiness so that they can determine whether you qualify for the loan and the amount and the interest rate at which they will grant you.

Before you can have a credit score, you need to have credit history. This can be achieved by opening at least one credit account which must have been opened for six months or more using FICO Score model. This account must have been reported to credit agencies within the last six months. If you don’t have any information in your credit file, it means there is nothing to calculate. However, VantageScore tries to capture people with no enough credit history in their own credit scoring model. I will explain this issue of credit scoring later for you to understand it better. You should understand that the fact that you are yet to establish a credit does not necessarily mean that your credit is bad. The only problem here is that you don’t have any information with the credit bureau which they can use to assess your credit score. Therefore, if you don’t have a credit yet, the step you will need to take may be slightly different from somebody who is having bad credit score and now seeking for how to repair or increase his score.

Credit Score Models

When it comes to credit scoring, there are many models being used to evaluate the creditworthiness of consumers in the market today. Besides FICO Score and Vantage Score, which are the two major ones, credit bureau agencies have their own scoring models. Also, there are industry based credit scores such as mortgage credit score, auto insurance score and bankruptcy prediction scores. The scoring model used to analyse your credit information will determine your credit score. That means, you may likely get two different credit scores as the algorithms used under these two models are not totally the same even though they are similar. You may be saying that you don’t need to know all this. I will say that this is very fundamental if actually you want to improve or improve your credit score. When someone is sick, all what he wants is for him to get healed almost immediately. But no doctor will start administering any drugs without the proper diagnosis of the sickness or diseases. Otherwise, medication will just be like when one is chasing shadow while leaving the substance unattended to. When a proper diagnosis is done, it will help the doctor to hit the nail on the head. So, if you want to improve your credit score, you need to know the areas where you are failing before you can take corrective steps. For people that are asking for how to improve credit score fast in 30 days, I need to tell you that it may not happen overnight as you expect. It may be gradual but if you take the right steps, you will soon see your credit score improving.

FICO Score

FICO is a brand name for Fair Isaac Corporation. The company was established in 1956 to develop credit scoring which lenders and other businesses can use to evaluate the creditworthiness of consumers. It introduced its first FICO credit bureau risk score in 1981. FICO  has built a reputation for itself over time. No wonder many lenders and other businesses still prefer its scoring model to other scoring companies.

How Credit Score is calculated

FICO uses the criteria below in establishing the credit score of individuals.

Payment history: This accounts for 35% of your credit score. As you can see, your payment history carries the highest weight when it comes to how your credit score is calculated. That is why you need to pay more attention to this if you want to improve your credit score. I will still use a simple example as illustration. When we were in school, there were certain courses that are considered core while the others are just auxiliaries. Your core courses are more relevant to your discipline. The core courses usually carry high weight. So, if a student could manage to score high marks in his core courses, he would most likely graduate with high grade. But if he scored high marks in auxiliary courses but manage to score average in his core courses, that student might just manage to score above pass in his overall credit points. You can apply this illustration to your credit score. It you actually desire to improve your credit score, you’ve got to lay more credence on your payment history. It takes into consideration all your payment history including late payments, missed payments, defaults, charge off, public records such as lawsuit or judgment, tax liens and bankruptcy. Some of this information will stay up to seven years in your report while bankruptcy can stay up to ten years. Notwithstanding, recent activities carry more weight than past transactions. For example, if you made late payments say like four years ago, the effects may no longer be much on your credit score if you have been paying your debt consistently for the past three years. On the other hand, recent late or missed payments will definitely have more negative affects your credit score.

Credit utilization ratio: Next to the credit history is your credit utilization ratio which accounts for 30% of your credit score. Credit utilization ratio is simply the ratio of your credit card balances to your credit limits. If you have just one card, this may be easy for you to calculate. For example, if your credit limit is $5,000 and your credit card balance stands at $3,000, then your credit utilization ratio is 60%. You will arrive at this by dividing your credit card balance by your credit limit and then multiply the result by 100. However, if you have more than one credit card, the credit scoring company will have to consider the credit utilization ratios for the individual card and the overall cards respectively. Let’s assume that you have three credit cards with the details below:

Cards Credit Limit Credit Card Balance
Card A $5,000 $2,000
Card B $3,000 $750
Card C $2,000 $100

The credit utilization ratio for the individual cards will be 40%, 25% and 5% for Card A, Card B and Card C respectively. To calculate the credit utilization ratio for the overall cards, you need to add the credit balances of all the cards and then divide by the total credit limits on the three cards and then multiply by 100. Total credit limit is $10,000 while the total card balance is $2,850. Therefore, your overall credit utilization ratio will be 28.50%.

What is the significance of credit utilization ratio to your credit score? The credit scoring companies believes that anyone with high credit utilization ratio may likely be stressed out financially. Therefore, extending further credit to such person may constitute a risk as he may not be able to pay it back. Experts advise that credit utilization ratio should be kept below 30%. Looking at the illustration above, the overall credit utilization ratio is okay while that of Card A is too high. It would have been better if you can arrange your spending in such a way that you don’t exceed 30% credit utilization ratio in any of the cards. Some people may tell you that lowering your  will help you to raise credit score 100 points overnight. This may not happen. You may then ask that how long does it take to improve credit score with this strategy? Well, it may take an average of 30 days before you start seeing the effects on your credit score.

Length of credit history: While calculating your credit score, the length of your credit history takes 15% of the factors that determine your score. If you have opened a credit account for a long time with good track of prompt payments, the scoring tends to favour you than someone who does not have up to one year credit history even though he has not had any default on his payments. The credit scoring model assumes that somebody who has maintain his credit in good order over a long period of time is likely to maintain the habit if advanced new loans. It may be difficult to predict the behaviour of somebody who has not maintained an credit account for more than one year. Prompt payments of his balance may just be to create first impression which he may not be able to sustain. Also, if you open your credit account long time but you don’t make use of it, you cannot claim to have good credit history. Credit scoring companies want to see how you have demonstrated that you are a good borrower. This can only be proved by taking credit and paying back as at when due. A known devil is better than an unknown angel, they say.

New credit account:  How many new accounts have you opened recently? This account for 10% of your credit score. Each time you apply to open a new account; an inquiry will be made on your credit. This will appear in your credit report as hard inquiry. Each of these hard inquiries has the tendency of lowering your credit score by few points. However, if a creditor makes a request on your credit file so that he can make a preapproved credit offer to you, this will not be accounted for as hard inquiry. Similarly, if an existing creditor makes an inquiry on your account in order to review your account with them, such inquiry will not be treated as hard inquiry. It is also possible you request for your own credit history. This is neither a hard inquiry. All these inquiries which are not hard inquiries are known as soft inquiries and they don’t affect your credit score.  If you open too many accounts within a short period of time, it could be assumed that you are having trouble with your finance. Recent hard inquiries on your credit will usually have more impact on your credit score.

Credit Mix: The last factor that is considered when calculating your credit score is the mix of credit you currently owe. The types of credit you owe constitute 10% of your credit score. Lenders will like to know how you have been able to manage different types of account such as revolving loans and instalment loans. Revolving debts include your credit card balances and lines of credit while instalment loans include personal loans, auto loans, mortgage loans and student loans.

Read Also: Credit Utilization Ratio and How to Keep it Low

Vantage Score

In 2006, the monopoly of FICO was broken when the three major credit bureaus namely Experian, Equifax and TransUnion came together to form VantageScore. Though the objectives of both FICO Score and VantageScore are the same, which is essentially to provide information that can help lenders assess the creditworthiness of potential borrowers, the two scoring models have little differences in their scoring formulas. For instance, in order to assess the credit score of people with limited credit history, VantageScore uses alternative data by factoring in reoccurring payments such as utilities, rent or phone bills into its scoring formula . However, the numerable scales for both FICO Score and VantageScore 3.0 range between 300 and 850. How does VantageScore calculate credit score? This is summarised below:

1 Bill Payment History 40%
2 Age and types of credits 21%
3 Percentage of credit limit used 20%
4 Total debts 11%
5 Recent credit inquiries 5%
6 Available credit 3%

VantageScore 2.0 which was the early version used the following criteria to calculate credit score.

1 Bill Payment History 32%
2 Credit utilization 23%
3 Total debts balances 15%
4 Age and types of credits 13%
5 Recent credit inquiries 10%
6 Available credit 7%

I may not need to repeat the explanation I gave on how FICO calculates credit Score. The main differences you can notice Score and VantageScore are; FICO uses five variables while VantageScore uses six variables to calculate credit score. Also, the weights attached to each variable are different. Nevertheless, the two credit scoring models give customers’ credit history highest ranking.

Range of Credit Score

I mentioned above that credit scoring for FICO Score and VantageScore  3.0 ranges between 300 and 850. Your score will determine whether you have good or bad credit score. If you know your credit score, you can look at the table below to know how to interpret the three-digit number. It is important to note that your credit scores using the two scoring models may be quite different. That is why it may be necessary to find out which scoring model is used to calculate your credit score. This will give you a glimpse of what go into the calculation.

300-629: Bad credit

630-689: Fair credit

690-719: Good credit

720-850: Excellent credit

Read Also: Using Secured Credit Card to Build Your Credit

Importance of good credit score

Some people think that their credit score is not that important to them since they don’t have intention to apply for loans. Even though you don’t have any plan to apply for loan, that does not mean you should not strive to increase your credit score. Below are the benefits of good or excellent credit score:

  • Ease of getting new job: As part of the background checks of individuals seeking for jobs, a sizeable number of employers now make inquiries on applicants’ credit. This means that a good performance at interview or excellent results alone may not necessarily qualify you to secure a job any longer. It will be painful for you to lose a job opportunity after you have pass through all the rigours involved in the interview process, only for you to be rejected on the ground of not having a good credit score. Good or excellent credit score can actually give you an edge over your contemporaries.
  • Get new apartment: Homeowners usually see their houses as investments. So, when you are seeking for an apartment to rent, the owner will be willing to release it to you on the assumption that you will be able to pay for the rent amount without default. The apartment is a source of income to the owner and he cannot afford not to receive the rent on time. Some landlords may require that you sign a document authorizing them to run a credit check about you. If your record shows defaults, late payments or eviction by your previous landlord, the homeowner may be unwilling to rent the apartment to you. On the other hand, if the report shows that you have a large amount of debt outstanding, the landlord may conclude that you will not be able to pay your rent. If at all you are able to get the apartment, you may not be given the opportunity to make monthly payment.
  • Access to loans: Those people with bad credit usually find it difficult to access loan from financial institutions. Of course, lending involves risk but the risk can be minimised through proper scrutiny of customers. And that is what the lenders do. They screen people with bad credit out and concentrate on people with good credit history. You should not blame them for this as they are into business. They want to make profits and they can’t afford to lose their capital. That is why they may be unwilling to lend money to people with bad credit. While there is no guarantee that you will be granted loans if you have good credit score, it will definitely provide you a leverage. If your application is rejected, it won’t be on the ground of having bad credit.
  • Loans at affordable rates: Loans come with a range of interest rates. A financial institution may offer a loan with interest rates ranging between 7 and 12% per annum. If you have excellent credit score, you may be offered the loan at the interest rate of 7% while other person who is not having a credit score like you is offered the loan at the rate of 12%. This gap may seem insignificant to you but when you apply it to the loan amount, you will appreciate the savings you are making from interest payment. For instance, if you borrow $20,000 at the rate of 7% while another person borrow the same amount at the rate of 12% for five-year duration, you will pay the interest amount of $3,761.44 while the other person will pay $6,693.34. That is $2,931.90 difference. You can see the amount of savings you will make. Apart from this savings, when interest rate is too high, the risk of late or missed payments becomes higher.
  • High credit limit: If you have good credit score, you will enjoy high credit limit. You need to understand the importance of this. It helps you to maintain low credit utilization ratio which in turn can help you improve your credit score. If you think that your credit limit is low, you can easily apply that your credit limit should be increased.
  • Insurance at affordable rates. People usually complain about high insurance rates. One of the factors that insurance companies consider in determining the rates that will be applicable to you is your credit score. If you have good credit score, you will be able to shop around. Your good credit score increases your negotiation power. At the end of the day, you will be able to buy your insurance at very affordable rates. Apart from the fact that people with bad credit may likely pay higher insurance rates, the insurers may not grant them the option to pay monthly. This may take toll on their cash flows.
  • Mobile phone contract: If you have good credit score, you may not need to pay any security deposit for signing a phone contract. You can also enjoy some discounts which people with bad credit may not qualify for. People with bad credit may be restricted to pay as you go plan.
  • Credit cards: Credit cards are not the same. While there are regular credit cards, there are others that target people with good credit cards. Such credit cards usually come with bonuses and rewards. So, if you have good credit score, you may qualify for such cards. If you are able to utilize your cards well, rewards and bonus you will be getting can help you save some costs. Besides, you can enjoy other benefits such as no annual fee. You still enjoy greater control and flexibility.

Read Also: Credit Cards Application and How to Choose the Right One

How to Increase Your Credit Score

Having read the benefits you tend to enjoy if you have good credit score, you can then go ahead to learn how you can improve your credit. If you want to improve your credit score, taking the following steps may help you achieve that.

  • Check your credit report: Before you take any step, you need to know the information contained in your credit report. You can do this by requesting for your credit report from any of or all the three major credit bureaus namely Experian, Equifax and Trans Union. It is important to note that it is possible to have varying credit scores from these consumer credit bureau agencies because they don’t share the data collected about consumers among themselves. So, in a situation whereby a creditor reports your credit information to just one or two consumer credit bureau agencies, there is no way they will arrive at the same credit score about you. That is why it is always better to get your credit report from the three consumer credit bureau agencies at the same time. This will give you the opportunity to compare the reports for possible errors or omission. You are entitled to one free credit report every year from the three credit bureaus. You can apply for your free credit report from annualcreditreport.com. The site is the only source for free credit report authorised by the federal law in the United States of America. The essence of checking through your credit report is to enable you review the information in the report for possible errors or omissions. You want to be sure that your identifying information such as your name, previous and current addresses, social security number, employment history and income are correct. Of equal importance are your credit information, public record information and inquiries made on your credit. Any strange information which you don’t know about may signify identity theft which you need to report to the credit bureau immediately. Please note that you will not find information about your medical history, race, religion or criminal record in your credit report.
  • Pay your bill on time. Do you know that utilities companies report to credit bureau any time you default in payment? This can dent your credit information. Even if the company does not report you directly to credit bureau agencies, your account may be transferred to collection agency. The agency may then report the debt.
  • Get a credit card. I have mentioned this enough. You can’t build credit without having credit history. And you can only have credit history if you have credit account. You may need to apply for secured credit card if you don’t qualify for regular credit cards. You should ensure that you use the card responsibly.
  • Set up payment reminders, payment calendar and automatic payments: Some people miss or delay payments, not because they want to do so or neither is it that they don’t have money to pay. The payment time simply gets off their mind. In order to avoid missed or late payment, you can arrange with your creditor to send you payment reminders every month. You can also set up your payment calendar. With smartphones, this is no longer difficult to do. Another thing you can do is to instruct your bank to make automatic payments from your savings account to offset whatever balance you might be having on your card at month end.
  • Reduce your debt: If you go back to the credit scoring models discussed above, you will realise that the amount of debt you owe affects your credit score. If you want to increase your credit score, you will need to reduce your debt to income ratio dramatically. There are many strategies you can employ to pay off your debts. Everything begins with determination. This may require that you change your spending habits. Create a budget for yourself and ensure that you live by it. Cut all unnecessary expenses that you know you can do away with. If you look around your home, you may realize that you have so many items that you don’t use. You can decide to sell all the unwanted items that you keep. This will help you raise some funds which you can use in paying down your debt.

Read Also: You Can Pay off Debt With These Strategies

  • Pay off collections and charge off accounts: You should be aware that collection accounts stay up to seven years in your credit report. Though the collection accounts may still remain in your report after you have paid them off, it won’t have much effect like when the accounts remain unpaid. It depends on the scoring model used to calculate your credit score, some may not include the collection accounts that have been fully paid in their calculation.
  • Pay your card balances promptly. You saw the impact your credit history has on your credit score whether FICO or VantageScore is used for your scoring. Late payment will stay on your account for seven years. In case you have had series of late payments, you can reduce the effects by start paying promptly. If creditors notice that you have been paying promptly and consistently in the recent times, they can easily overlook the previous late payments. The older the late payments become, the lesser effects it will have on your credit score.
  • Don’t close unused credit card: If you have credit card you have not been using, you can be tempted to close the card. This act may not help your credit score especially if the card has good credit history. Also, closing the card may reduce your available credit limits thereby making your credit utilization ratio to increase. I like illustrating with example as I believe it will help you to understand me better.

Let’s assume that you have 3 cards with the following details:

Card Balance Credit Limit
1 0 $3,000
2 $1,000 $3,500
3 $700 $2,500
Total $1,700 $9,000

We need to first calculate the credit utilization ratio of individual card. If we divide the credit balance of each card by the credit limit on the card and then multiply by 100, the credit utilization ratio of Card 1, Card 2, and Card 3 will be 0%, 28.57% and 28% respectively. The overall credit utilization ratio will be 18.89%.

Supposing you now decide to close Card 1, your total available credit limits will fall to $6,000. This will make overall credit utilization ratio to increase to 28.33%. Although, credit utilization ratio of 28.33% still looks reasonable, you will be putting much pressure on the other two cards. The spending you would have made on the card you closed will now be made through either of the two remaining cards. This may make your credit utilization ratio to hit the roof. Besides, you will be losing the credit history you have built over time on the card you close. Therefore, before you close any card, it is important to weigh the effects it might have on your credit score before you take the decision.

  • Avoid opening new accounts you don’t need. You may receive pre-approved offers from credit card companies. That does not mean you should grab the offers. It doesn’t matter whether they have pre-approved you, they may still make fresh inquiry on your credit file if you accept the offer. It is considered a fresh application. You should only apply for a credit card when you actually need it. Also, if you make multiple credit card applications, it makes you to appear that you are desperate for finance. In case you like to shop around in order to get cheap rates, you can use online tools to find out whether you qualify for a particular card or loan before you apply. There is one thing you need to know about opening a new account,it will lower you average account age.
  • Don’t max out your credit. Ensure that you don’t max out your credit. It is better to keep your credit utilization ratio below 30%. If you think that this might not be possible, you can choose to pay off your card balance twice in a month. Your card issuer will likely report your card balance at the end of the billing cycle to the credit bureau agencies. This means that the credit bureau may not know how much you actually spent on your card in a given month if you make payment on your card balance at the middle of the month. Some people has a wrong conception about maxing out their cards. They believe that it doesn’t matter how much they spend with their card in as much they pay off the balance at the end of the month. If you have been doing this, that may be the reason while your credit score is low. If you can work on this area and ensure that your credit utilization ratio is kept below 30%, you may be able to raise your credit score 100 points, all things being equal.
  • Negotiate with your lender: If you fall behind in your payments, it may be good you negotiate with your lender. Negotiation works at times. Your creditor may even help you to waive or reduce your interest payment. However, you must be able to demonstrate your commitment to pay off the debts within a reasonable period. Also, when the payment is completed, you may plead that he should help you write to the credit bureaus to remove the record of late payments from your credit report.
  • Increase your credit limit: If your income has increased significantly from the level it was when you first opened your credit account, it may be the right time to request that your credit limit is increased. If you can prove the increase of income to your card issuer, he may not hesitate to increase your credit limit for you. What will this help you achieve? You will be able to reduce your credit utilization ratio. However, if your card issuer refuses to increase your credit limit, it may be a time to for you to open a new account if you know you really need it.
  • Become authorised user of another person’s card. This is one of the ways by which you can increase your credit score fast. What does this entail? You will need to approach someone who is having a good credit history and you know that he will always pay his account balance promptly. The person will make you an authorised user of his account. By this, you will have good credit history the same way the person has. However, you can only do this with someone who really trusts you.
  • Beware of joint account: If you had a joint account which you no longer use, it is better to close the account completely. The reason is that, whatever the other person does with the account will equally affect your credit score. Therefore, in case of divorce, you should ensure the person no longer have access to your account.
  • Get a credit rebuild card: If your credit is already bad, you may find it difficult to get a regular credit card. In this case, you need a credit card designed for people bad credit. A good example is secured credit card. If you are applying for a secured credit card, you will need to make a deposit up to the amount of your credit limit. The deposit serves as collateral. So, if you default in paying your card balance, the lender can fall back on the amount you deposited as security. The interest rates on secured credit card can be very high. But you should not allow you to stop you as you will not need to pay any interest if you don’t carry balance on the card. If you use the card responsibly consistently for twelve months, the card issuer may waive the collateral.

For people asking for how to increase credit score fast, I will like to say that it takes time for you to build your credit score. But if you are patient and consistent in using your card responsibly, you will soon start to see some improvement in your credit score.

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