9/27/2013 6:00 PM ET|
How to improve your credit score
These simple steps will help you stay on top of your credit rating and qualify for the best possible rates.
Lousy credit scores can cost you a fortune.
You'll pay higher interest rates, larger insurance premiums and bigger security deposits for cell phone and utility service. That's assuming your applications aren't simply denied. Bad credit can keep you from getting the mortgage, the apartment or the insurance you want.
So rehabilitating troubled scores, or building credit from scratch, pays off. The following steps can speed the process:
Kill the lies. Many credit reports contain errors, some of them serious enough to affect your creditworthiness. The only place online to get your free annual look at your credit is annualcreditreport.com. Don't fall for lookalike or soundalike sites. Focus on the big mistakes you find, such as accounts that aren't yours or payments that have been reported as late when they were made on time.
Make some debt disappear. One of the best and fastest ways to improve mediocre credit scores is to pay off credit card debt. The FICO credit scoring formula pays a lot of attention to the amount of credit you're using vs. your credit limits. Balances on revolving lines (such as credit cards) matter more than balances on installment loans (mortgages, car loans, student loans).
If you can't pay down your credit cards right now, consider moving some of the debt to a personal loan. Credit unions often offer three-year personal loans with fixed interest rates and payments.
Another, far trickier maneuver is to pay off credit cards with a 401k loan. Loans from workplace retirement plans don't show up on your credit reports at all, so it's like the debt has disappeared. But if you lose your job and can't pay off the loan quickly, you will incur a fat tax bill and lose all the future, tax-deferred returns you could have made.
Use only a fraction of your available credit. A reader emailed me after looking into one of her FICO scores. She was told her score was lowered because she had larger than normal credit card balances. "I pay off all my credit card balances in full each month!" she protested.
It doesn't matter to the FICO formula whether you pay in full or in part. What matters is the balance you owe on the day that your credit card company reports its accounts to the credit bureau.
So if you want better scores, you'll have to limit how much you charge. The less you charge, the better. Using 30% or less of your limit is good, 10% or less is best. FICO "high achievers" -- those with credit scores over 785 -- use an average of 7% of their available credit, according to a study by MyFico.com.
Piggyback on someone else's good credit. Getting added to someone else's credit account can boost your credit scores if the other person handles credit responsibly. This does not work with all accounts, so you may have to check with your card issuer.
And choose your cardholder wisely. Another reader, Tammy, added her college-age son as an authorized user of one of her credit cards to help him build credit. Then she ran into hard times and started carrying a big balance.
The card "is showing up on his credit report with a high debt ratio, as he has no card of his own," Tammy wrote. "Will it hurt his credit score to remove him as an authorized user from this card? I don't want to cause any more damage."
Yanking her son's only credit account indeed would cause more damage. His best bet is to add another card to the mix, and that may have to be a secured card.
Get (and use) a secured card. These require you to deposit some money, typically $200 to $2,000, as collateral for the card. To build credit, the account should report to all three credit bureaus. Use the card lightly but regularly and pay the bill on time. (Don't expect your account to be paid from your deposit—that only happens if you default.) You can find a good secured card through CreditCards.com, CardRatings.com or NerdWallet, among other sites.
Add an installment loan. Thomas had a good job and no debts. What he didn't have were credit scores, since his credit history was built in another country (Holland). So he started building credit with a secured credit card, and then got a second, unsecured account. He asked me what to do next to continue building his credit so he could get a mortgage.
"I am planning to pay my car in cash," he wrote, "or should I not do that?"
In his case it might make sense to make a sizable down payment and take out a relatively short-term loan to get the beneficial effects of paying off an installment loan.
Don't sweat the small stuff. Karl was outraged when he got a letter from lender turning him down for an auto loan. The thing was, he already had bought the car, thanks to a loan from his credit union. The second loan application was a mistake, started by the auto dealership but never canceled. Karl wanted to know what he could do to get the second inquiry off his credit report.
Unwanted credit inquiries are annoying, but the damage was likely minimal. The FICO formula counts all auto-loan related inquiries made within a short time span as a single inquiry. Mortgage inquiries are treated the same way.
A single inquiry typically reduces a credit score by 5 points or less, and even that small negative effect fades completely within a year. You shouldn't open a slew of new accounts in a short time, but you also don't need to worry excessively about any single inquiry.
Neither do you need to keep obsessing about your scores once you reach FICO levels of 750 or so. Beyond that, higher scores don't win you any greater access to credit or lower interest rates. Just continue to use credit responsibly, and you should get the best deals available.
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