Credit scores. . . To many of us, they seem like arbitrary numbers that can be frustratingly impossible to manipulate. To others, credit scores are quite the opposite; understanding and improving them has become a challenge from which many financial benefits can flow. When I sit down with a client who has been dealing with less-than-wonderful credit, they usually know which financial mishaps and choices got them there. And although time and the responsible use of credit cards for bad credit should help them finally regain control, understanding what makes up a credit score could have kept them out of trouble in the first place.
The First Step in Improving Your Credit Score
I’m a firm believer that the first step in anything is acknowledgement, or awareness of your current position and how it affects you. You are entitled to one free credit report from each of the three credit bureaus every year, so this is where your journey should begin. On your credit report, which you can obtain via www.AnnualCreditReport.com, you will be able to see all the various things on your credit file, but unfortunately you will not see how they affect you or your actual credit score. As I have mentioned before, your credit score affects practically everything in your life. And while viewing your credit report is certainly a step in the right direction, what you really want to know are your FICO scores. So, begin by reviewing your credit reports for errors or missing information. If you find anything incorrect or strange, dispute it immediately. Next, go to myFico.com to take a look at your actual FICO scores- you have one based on each credit report from the three major credit reporting agencies. Unfortunately, Experian won't sell you your FICO score anymore, so you'll only have access to Experian and Equifax-based FICO scores.
Understanding What’s in a Credit Score
Once you get your credit scores, understanding them is the next most important step towards improvement. Below are the five basic categories included in your credit score: 1. Payment History (35%) - A lender’s biggest concern is if you can be trusted to repay money that you borrow. Have you been late before? If so, how often? 2. Amounts Owed (30%) - Even if you can be trusted, lenders want to know about your credit utilization. How much credit do you have available, and how much of that are you using? The lower the ratio (lenders love 30% or less), the higher your score. 3. Length of Credit History (15%) - Somebody who has paid their bills on time for 30 years has earned a little more trust than somebody who has paid their bills on time for six months. 4. New Credit - (10%) - Too many inquiries and new credit accounts could make you seem desperate to prospective lenders. 5. Types of Credit Used (10%) - Are you able to handle multiple types of credit?
The Most Important Step in Improving Your Credit Score
Now that you know your credit score and how it's computed, make it part of your life. You don’t need to be obsessive about the actual number, but remembering these five categories when you make financial decisions will help you keep moving in the right direction. A difference of 100 points on your credit score could cost you tens of thousands of dollars in interest charges, so this isn't something to take lightly. I’m sure we can all think of other things for which we would rather use our hard-earned money. Can't you?
Photo credit: Shutterstock / Stuart Miles
