How to improve your credit score
I did a post on Instagram a few days ago and had quite a few good questions relating to this topic. But before we get into what impacts our credit score and how to improve it, I think it's best to explain what it even is and why it exists.
A credit score is a 3 digit number that usually ranges from 300 to over 850, depending on which model is used. It's designed to represent your credit risk, or how likely you'll pay your bills on time. There are many different types of models and some use other data, such as your income, to calculate your credit score.
Creditors, such as banks and credit card companies and potential lenders take into account your score when weighing up whether they should lend you money or offer you credit. Generally the higher your score the more favorable credit terms you'll have access to.
Some places try to charge you to get access to your credit score but there are plenty of free resources, such as Credit Karma or Credit Simple that offer this service free of charge. Most of them have an app to download and it makes it really easy.
The most widely used system is what's known as the FICO system and it ranges from 300 - 850. Take a look below for a better view of the ranges.
Ranges of the credit score
300 (or below):
This typically means you don't have any credit history and haven't established any accounts.
300 - 629 (bad):
Significantly damaged credit history. Can be a result of defaulting on multiple loans, regularly missing payments or as a result of bankruptcy (which stays on your account for 10 years).
630 - 689 (fair):
Considered the "average" range. A few little scrapes and bruises on your history but no major issues. You'll still have access to majority of credit offers although they will come with higher rates.
690 - 719 (good):
A score in this range will get you access to the majority of credit options out there but won't quite get you the "best of the best" rate offers. You'll be able to get unsecured loans (loans that don't require any collateral) almost certainly if your score is at the higher end of this range.
720 - 850 (excellent):
The Mt. Everest of the credit scoring world. You're at the peak. With a score in this range you have demonstrated excellent management of borrowed money and will have access to the lowest rates possible.
The importance of the score
Those with higher scores generally get access to the lowest rates, which translates into less interest paid over time.
Remember, the types of credit scores used can vary by industry. If you're buying a car for example, the lender might put more of an emphasis on your payment history when it comes to auto loans.
What impacts my score?
The score can be broken into 5 categories with different weightings of each. Payment history and credit utilization (amount owed) are by far the two most important factors to consider.
35% - PAYMENT HISTORY:
If you pay all of your bills on time you'll be doing pretty well in this category. This includes more than just credit repayments too. Phone bills, electricity bills, mortgage repayments, and others, can all play a part in your payment history. This is one of the categories that most lenders will look at first when sizing you up for a loan.
30% - AMOUNT OWED
I like to refer to this as "credit utilization" rather than amount owed. It's easier to understand that way. This measures how much of your available credit you use, not how much total credit is available. Have a $20k credit card and only use $2k, your utilization is 10% (2/20=10%).
Some folks have 6 or more credit cards for different reasons such as travel rewards, cashback, lounge access, etc., and their available credit could be $80k total. But if they only spend $4k of that per month their utilization is only 5%.
Keep in mind that "amount owed" tallies up all of your debt, including your mortgage. So if you have a $200k mortgage, $10k credit card maxed out and $4k personal loan, your total owed would be $214k. If you're able to make the regular repayments on time, every time, then there's no need to be worried.
However if your debt-to-income ratio is creeping too high (above 35% usually), you'll have a hard time getting a lender to give you a loan because what you earn doesn't calculate to be enough to consistently repay your debts. Something to keep in mind.
15% - LENGTH OF CREDIT
A measure of how long you've had and used a credit facility. Whether that be a phone bill in your name, a mortgage or a car loan, they all impact your length of credit measurement.
An important note is this measures average credit length and not total credit length. If you have 1 credit account for 10 years, your average length of credit = 10 years (10/1=10).
However if you have 1 credit account for 10 years and open a new credit account in the 10th year, your average length of credit will be 5 years (10/2=5). That's why some people advocate opening multiple lines of credit early and before they'll actually need it so their length of credit doesn't get knocked around too much. Something to keep in mind when applying for new credit or loans.
10% - TYPE OF CREDIT
This measures the mix of credit types you use. If you have a mortgage, credit card and a Line of Credit facility you would be seen as managing 3 different types of credit.
Don't worry, you don't have to have a mix of all types of credit to have a good score in this area.
10% - NEW CREDIT ACCOUNTS
This measures every time you open a new credit account or you have a "hard inquiry" into your credit history (like when you apply for financing for a car). If you apply for multiple credit cards or loans within a short period of time expect this portion of your credit score to take a hit.
Ways to improve your credit score
Pay your bills on time
A sure fire way to pump up your credit score is to pay all of your bills on time, every time. Prioritize making your regular payments, even if it's the minimum, and never miss a payment even if you're disputing something with your provider.
Lower your credit utilization
This might sound counterintuitive but consider upping your credit card limit. To be clear, you do not intend to spend near the limit, instead it just gives you more credit available to use. Keep you credit utilization under 30% if possible.
Reduce your debt-to-income ratio
Some lenders may not want to give you a loan even if you have a great credit score if your income is what they consider "too low". Either increase your income by taking on more shifts or starting a side hustle, or decrease the amount you owe by smashing down your debts.
Apply for credit only if you need it
Consider spacing out when you apply for new credit lines such as additional credit cards, financing or loans. Trying to open too many credit facilities at once will raise a red flag to lenders and will impact your credit score.
Only close a credit account if you have to
If your credit card has no annual fee, don't close it. You can pay it off, cut it up and forget about it if you want to, but there's really no need to close it. Also if that is the only line of credit under your name, closing it can have a massive impact on your credit score.
If you find yourself wondering why your interest rates or credit options are different from other people you know, your credit score is a good place to check as a starting point. Knowing your number can help you identify areas where you need to improve, such as paying your bills on time or not maxing out your credit card.
At the end of the day your credit score is just a number and one of the indicators (not the only one) of your financial situation at a point in time. Adopting good money management habits is the number one way to improve your score without even having to look at it.
I'm keen to hear from you on your situation and experiences in the comment section. Let me know if you have any questions and I'll try my best to answer them. Oh, and share this around if you found it useful!
Blake - FIRE with a family