How to Build and Improve Credit

How-to-Build-and-Improve-Credit

Understanding credit scores can be a confusing and overwhelming process. How many of us have experienced the frustration of being caught off-guard at what our credit score is? You may have questions like: What is this mythical number and where does it come from? What does it mean for me and why does it matter? How can I raise my credit score and what can make it drop? With the spike in interest rates we have seen the last few years, having a high credit score to get you favorable loan terms is critical. This introduction will help you understand what credit scores actually mean and best practices to manage your credit rating.

Your credit score is one of the most important numbers when it comes to personal finance. It can impact your ability to qualify for financing for credit cards, an auto loan, and a big-ticket item like a home mortgage. Credit scores help lenders predict the risk of a borrower not repaying a loan. The FICO score analyzes the data on your credit report, then predicts how likely a borrower is to pay a bill 90 days or later within the next two years. The FICO name derives from the Fair Isaac Corp, which introduced the FICO score in 1989. There are other types of credit scores, but the FICO Score is by far the most popular, used by about 90% of the top lenders in the United States.

You may be able to check your credit score through your bank and most major credit cards now offer you a free credit score. There are other agencies that you can use that charge a fee. Below, we will share information on how to obtain your credit reports for free. It is important to note that credit scores and credit reports are not the same thing.

Credit score ranges vary based on the model being used, but generally they fall within these score parameters:

CategoryRange
Excellent850-800
Very Good799-740
Good739-670
Fair669-580
Poor579-300

These are the biggest factors that can ding your credit score:

  • Missed or late payments
  • High Utilization – Your outstanding balance is close to your credit limit amount
  • Bankruptcy
  • Opening multiple new credit accounts or loans at the same time
  • Errors on your credit report

Your credit score is based on the five following weighted factors, each one has an impact on your overall credit score, but some are more important than others.

CategoryPercentage
Payment History35%
Amounts Owed30%
Length of Credit History15%
New Credit10%
Credit Mix10%

Let’s break them down.

Payment History 35%

Your bill-paying track record is the largest determining factor in calculating your credit score, making up over a third of your overall score. The big question lenders want to know: Do you make payments on your debts on a consistent basis? Not only do they look for any late payments, but if any late payments are flagged, they will dig deeper. To that point, they evaluate how late the payments were, how many late payments are on the report, and how long ago the late payments occurred. One missed payment can hurt, but if a poor pattern develops, it can take years to climb back to a good credit score.

This doesn’t just apply to your credit cards. If you fail to pay your bills, you risk the company whose payment you neglect, reporting that late payment to the credit bureaus. A late payment on your report can negatively impact your credit score for up to seven years. Yikes!

Amounts Owed 30%

A comparison will be made between your total outstanding credit available versus your actual balances. This is referred to as your credit utilization rate. Try to keep your balance, both overall and on each account, under 30% credit utilization. Try to keep the balances low even if you are paying them off every month. 

Length of Credit History 15%

This factor looks at how long you have had your credit accounts open. The older your average credit age, the higher this portion of your credit score will be. If you have old credit cards you are no longer using, you might want to keep them locked in a drawer or in a safe rather than closing them. If you close them, it will have a negative impact on both your average credit length and lower your credit available adversely, knocking a few points off your score.

New Credit 10%

When you apply for new credit, a lender will pull a copy of your credit score. This is called a “hard inquiry” and will appear on your credit report for 24 months. Too many of these “hard inquiries” bunched together over that two-year period can lower your credit score. That is something to consider if you are planning on taking out several loans over a short period of time.

It is important to recognize the difference between a “hard inquiry,” which impacts your credit score and a “soft inquiry,” which will not ding your score. A “soft inquiry” happens when you check your own credit report or use a credit monitoring service. A “soft inquiry” also includes when companies make promotional offers of credit, or your lender conducts periodic reviews of your existing loans.

Credit Mix 10%

A variety of different types of loans can raise your credit score. Creditors like to see different types of loans being paid off, from your mortgage, to auto loan, to credit cards.

Credit Score by Generation

It is interesting to examine the average credit score by generation. Here is the data from VantageScore Credit Gauge from May of this year. You will notice the younger generations’ credit scores lagging:

GenerationCredit Score
Silent Generation (born 1928 to 1945)738
Boomers (born 1946 to 1964)741
Gen X (born 1965 to 1980)707
Millennials (born 1981 to 1996)684
Gen Z (born after 1996)662

Now is a Great Time to Check Your Credit Report

There are three credit reporting agencies that can provide your credit report: TransUnion, Experian, and Equifax. Your credit report gives 10 years of credit history, it does not contain the actual credit score. The three agencies date back to when they served regionally, although they now serve nationally. The three reporting agencies each have their own method of collecting and updating information, which is why it’s best to retrieve your report from all three agencies. In addition, most creditors report to all three, but some don’t, so it is worth reviewing the information from all. 

The Fair Credit Reporting Act (FCRA), a federal law, requires that the credit bureaus must make sure the information they collect is accurate, give you a free copy of your report once every 12 months, and give you the opportunity to correct any mistakes. You can retrieve that information at: AnnualCreditReport.com. Due to COVID, they are offering free reports once a week until the end of 2023.

It’s important to ensure your credit history is accurate, as mistakes can occur. If you find any discrepancies, you should write a letter to the particular reporting agency, making sure to include supporting documentation.

If You’re Just Getting Started

Credit Scores can be very important to young people just starting out on their own. While they may be newly out of college, a credit score is one vital test score that can greatly impact their life moving forward. Credit scores can impact the interest rates that will be given on loans, to job employment screens, to screening for housing applications. Understanding your credit score is imperative for young people. Here are some tips to helping your child get their credit launched:

  • Authorized Usership is when you add a student as an authorized user to a parent’s card. After 45 days, the student will begin to see credit established. After a year or two of use, it will become easier to establish their own line of credit. If you decide to add your child to your account, it is a good idea to use a separate card that is not your primary credit card.
  • Plan ahead and establish who will be responsible for making the payments and paying in full each month. Discuss the credit limit that is on the card.
  • Secured Credit Card: Getting a prepaid credit card from a bank with a cash balance is another simple way to establish one’s credit. 
  • Pay all of your bills on time. The easiest path to a bad credit score is to have missed payments on your record. Pay on time every time. Consider setting up auto-pay to avoid missing a date.
  • Establish a payment history for at least six months that shows on your credit report when building credit from scratch.

If you have credit card or student loan debt, we can assist you with a financial plan that will target paying those balances off. Helping you understand your credit score is not just about numbers; it’s about providing the keys to financial empowerment and success. We also have other budgeting templates that can assist you in keeping on track for your financial goals. Understanding your credit scores can be a valuable tool to help you take control of your financial well-being. Contact the Bedell Frazier Financial Planning Department today, we are here to help!

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