You’ve probably loaned money to someone before, even if it was $10 to a friend who forgot their wallet when the two of you went out to lunch. When you loaned your friend that money, you might have thought they’d never pay you back, you may have been sure they would, or something in between. That gut feeling about the chance of being repaid comes from knowing that person.
But what if you didn’t know the person you were lending money to? Lending institutions would face this dilemma if it weren’t for credit scores, of which there are many. For the sake of this post, let’s focus on FICO® since it’s the most common and will give us a good overall understanding. Once you understand credit scores, you can impact yours for the better.
There are three major credit reporting agencies (CRAs) are Experian, Transunion, and Equifax. They collect consumer credit information and sell it to businesses in the form of a report. CRAs receive their data from businesses and public records.
Fair Isaac Corporation, or FICO, creates three versions of its base score from data from each of the CRAs. They are made up of the following categories and weights:
35%) Payment history: includes on-time and late payments on credit accounts, and public records related to non-payments, such as a bankruptcy.
30%) Amounts owed: on credit accounts, such as installment loans (i.e. auto or mortgage) and credit cards, and your utilization rate (how much credit you’re using compared to what is available to you; it’s better to use $2,000 of your $5,000 credit line than $4900).
15%) Length of credit history: the age of your accounts (oldest and newest) and the average age of all your accounts are worth about 15% of your scores, along with how long it’s been since you last used specific accounts.
10%) Credit mix: the types of accounts you have, such as credit card accounts, mortgage loans and retail loans.
10%) New credit: new credit inquiries and recently opened accounts.
According to CreditKarma, scores range from 300 to 850, and you can break those down into tiers:
Bad credit (300-579): can make it difficult to qualify for credit at all.
Fair credit (580-669): gives you more options, but you'll likely pay higher interest and will have a limited choice of credit cards.
Good credit (670-739): can give you lower interest rates and more choices.
Very good credit (740-799): can give you access to most rewards credit cards and the lowest interest rates offered.
Excellent credit (781-850): guaranteed lowest rates; options are not very different from “very good credit.”
It comes down to this: the higher your credit score, the more options you have for borrowing and the less you’ll pay in interest.
Now that we know which categories affect our credit and to what degree, it’s time to improve our scores. Here are 10 steps to take to improve your credit, according to The Balance:
Get a copy of your credit report: you can get free copies of your credit reports from each of the major bureaus from AnnualCreditReport.com.
Dispute credit report errors
Avoid new credit card purchases
Pay off past due balances if you can
Do not apply for new credit
Leave accounts open, even if you don’t plan to use them
Call your creditors
Pay down your debt
Get professional help
Be patient and persistent
Are there immediate steps you can take to improve your credit? I’d bet there are. Make a list, take a deep breath, and start working on it. If you stay consistent and patient, you’ll have a higher score in no time.