While doing a bit of car shopping a few years back, the car salesman asked my wife and me if we had had a loan before, if we knew our credit score, and how old we were. We told him that we hadn’t had a car loan or mortgage but that we had excellent credit.
A few minutes later, we were told to speak with a new salesman. When I asked the new salesman why we had been handed off to him, he told us, “I’m the guy that helps people with poor credit.” At that point, I about walked out the door. Just because we were young and “appeared” to have no credit history, this salesman assumed we had poor credit and never would have suspected that I had a credit score of 800 and would have no problem credit qualifying! Now mind you, I was 24 at the time.
On our way out the door, I spoke with the original salesman and expressed my frustration with being reassigned to the “poor credit” guy. When I told him my score, he asked how I had ever managed that.
So what did I do, and what can you do to increase your credit score?
First, you need to understand what the credit agencies are considering. There are essentially five factors with corresponding weights that determine your credit score.
- Payment Record (35%)
- Total Amount Owed (30%)
- Credit History (15%)
- Application History (10%)
- Credit Mix (10%)
As you look at that list, keep in mind that the objective of each credit bureau is to generate a number that tells a creditor how safe they are when extending credit to you. In other words, your past and current behavior indicates how likely you are to repay the borrowed amount on the agreed schedule. Now let me explain what each area above entails and what you can (and should) be doing to help boost and maintain your credit score.
Let’s dive deeper into each factor of your credit score
Your Payment Record shows how consistently you pay your bills on time. As you can see, this is the largest factor when determining your credit score. Creditors want customers who they can expect to always pay the bill by the due date. So what we are really talking about is your self-control. If you have enough self-control to not overextend yourself, then you will be able to meet your current and future obligations. If you do not live within your means (i.e. spend less than you make), then you will have a poor payment record showing late payments.
Let me give you quick tip if you do have some late payments showing up on your credit report. First, speak with the creditor about having the negative information removed from your credit reports (assuming you have reconciled with the creditor). If you have a single blemish, then they are usually pretty willing to work with you. Second, appeal directly to the credit bureaus to have the late payment information removed, especially if there was any mistake on the part of the creditor. For example, Old Navy once didn’t send me my monthly statement. I didn’t think anything about it until the next month when I found out I had a late payment due. I spoke with Old Navy, made the payment, and reconciled everything with them. Sometime later, I discovered the late payment on my credit report. I disputed the late payment with the credit bureau by explaining the situation in about 50 words and the late payment was promptly removed from my credit report.
Second, your Total Amount Owed is an indicator of your current ability to meet future obligations. For example, someone who has $1,000 in debt is probably more likely to be able to handle additional debt than someone who has $10,000 in debt. You should consider your total amount owed by calculating your ratio of credit used to total credit available. So, if your total credit limit (once you add up all of your credit limits) is $20,000 but you only have $2,000 in used credit, then your ratio is 1 to 10 or 10%. Again, this metric is a measure of self-control. Just because you have available credit, you do not have to use it. Creditors want to know that you are not maxing out your cards and taking on “too much” debt. A simple rule of thumb is to keep your ratio of credit used to credit available below 20%.
Third, your Credit History is determined by looking at all of your credit accounts. Creditors want to see that you have had other credit accounts for a long period of time and that the accounts are in good standing. Meaning, you need to have credit accounts that have been open for many years. The credit bureaus prefer to see accounts that have been open for literally decades. For example, I have a card that has been open and in good standing for over seven years, which is considered “too short” by the credit bureaus. Therefore, leave your credit accounts open even if you are not using them. This also helps to decrease your credit used to credit available ratio. One caveat, don’t have too many credit accounts open. If you have quite a few cards and need to close some, just close recently opened cards.
Another important part of your credit history is showing that you have used your credit. Sometime ago, I had Trilegiant perform an analysis on my credit (more info on Trilegient in another post). One of the critiques that I received was not using my oldest credit account. So even though the account had been open for years and had a great payment history, the lack of use was not helping my credit score. Meaning, use your credit accounts from time to time even if it is just a small amount.
Fourth, your Application History is a record of how often and how many times you have checked your credit (also known as “inquiries”). The logic is that if you are frequently checking your credit, then you intend to use it and potentially overextend yourself. There is no perfect number of times of how often you should check your credit in a given time period. However, inquiries are removed from your credit report after 24 months (though only impact your credit score for 12 months). A good rule of thumb is no more than 3-5 inquiries in a 12 month time frame.
The last factor is your Credit Mix. Credit is grouped into different types: installment and revolving. Installment credit is credit that has a fixed number of payments, so basically a loan. Your mortgage, auto loan, personal loan, or student loans are all types of installment credit. The other type, revolving, does not have a fixed number of payments. Most know revolving credit as credit cards or department store cards. Having a mix of credit shows that you know how to handle different types of credit. Also, try not to have too many credit accounts of one type (e.g. Kohl’s, Macy’s, Sears), which can decrease your credit score. If you are able to diversify your credit mix, then you are more likely to receive additional credit later.
Managing your credit is essential since so many things depend on it
You should evaluate the current status of your credit score and credit report for growth opportunities. Then, create a written action plan to improve your credit.
For additional information on improving your credit score, I’ve posted a brief YouTube video title “How to Improve Your FICO Score.”
(This post was featured in the Carnival of Twenty Something Finances)