Managing Debt: Improving Your Credit Score

Managing Debt: Improving Your Credit Score
Eileen St. Pierre, The Everyday Financial Planner

It seems like your credit score is used to judge you for everything nowadays, from determining utility deposits and car insurance rates, to whether you’ll get that job promotion. I’ve never used an online dating site, but I wouldn’t be surprised if potential suitors started asking for your credit score as a measure of compatibility. Seriously though, the resulting credit crunch in the aftermath of the housing crisis has now raised the bar on what is considered a good credit score.

The most widely used credit score is the FICO® score. It ranges from 300 to 850:

  • 760 – 850 Excellent
  • 725 – 759 Very Good
  • 680 – 724 Good

The range for a good score has narrowed over the years. Your credit score will determine the interest rate you pay on a loan. Taking steps to improve your credit score can pay off financially:

  • Decreasing your interest rate from 5% to 4.5% on a $200,000 30-year mortgage can save you over $60 per month and almost $22,000 in interest over the life of the loan.

Here’s how your credit score is calculated:

Payment History
This category makes the greatest contribution to your score. Unfortunately, missing or making late payments in the past cannot be fixed overnight.

  • Going forward, always pay your bills on time.
  • If you have missed payments, get current and stay current. Older credit problems count less towards your credit score.
  • Set up automatic payment reminders via text or email.

Amounts Owed
This category can be more easily cleaned up than Payment History but it takes discipline.

  • Keep balances on your credit cards and other revolving credit low – don’t exceed 30% of your credit limit.
  • Read this Money Talks News story on how canceling credit cards you are not using impacts your credit score.
  • Paying down an installment loan (like a car loan) is looked upon favorably.
  • Pay off debt instead of moving it around.
  • Only open new credit accounts when you need them – don’t open them just to increase your available credit.

Length of Credit History
Your credit score is affected by:

  • The age of your oldest account
  • The age of your newest account
  • The average age of all your accounts
  • How long it has been since you have used your accounts

A long credit history is better than a short one.  If you have a short credit history, don’t open too many new accounts all at once.

Types of Credit
Your mix of credit (credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans) also affects your score. It is not a major factor, but it can become important if there is not as much information on your credit report to calculate a credit score. But don’t open accounts just to have a better credit mix – it probably will not help raise your score.

New Credit Inquiries
There are two types of credit inquiries – soft and hard. Only hard inquiries will appear on your credit report and affect your credit score.

Soft inquiries occur when

  • You pull your credit report (www.annualcreditreport.com) or access your credit score.
  • Your employer or insurance company inquires about your credit history.
  • Your current lender does a periodic review of your credit history.
  • A credit or insurance company accesses your credit history to send you promotional offers. [You can permanently opt out of these offers by going to www.optoutprescreen.com.]

Hard inquiries occur when you shop for credit, such as a mortgage or car loan. They will remain on your credit report for 2 years, but FICO® only considers inquiries over the last 12 months.

  • According to Gerri Detweiler at Credit.com, limit your credit shopping to a two week period so that it is counted as a single inquiry. This should only cause a drop in your credit score by less than 5 points.

The FINRA Investor Education Foundation provides free credit scores to active duty military members and their spouses (through the financial educator or PFM at their installations).

Just knowing your “number” is not enough.  The next column in the Managing Debt series will help you understand your credit report.

Visit my Debt Management page for more information.