Improving Your Credit Score

Your credit score is an important measure of your financial health. It signals to lenders how responsible you are at utilizing credit. The higher your score, the easier you will find it to be approved for new loans or lines of credit. Higher credit scores can often lead to lower interest rates on debt as well. There are a number of methods you can use to increase and improve your credit score. While it is going to take some time and effort, this week we’re covering strategies you can use to achieve that better credit score.

While there are a number of credit reporting companies out there, we’re going to concentrate specifically on FICO (Fair Isaac Corporation) scores. FICO credit scores are used by more than 90% of top lenders, and they’re composed of five distinct factors:

• Payment history (35%)
• Credit usage (30%)
• Age of credit accounts (15%)
• Credit mix (10%)
• New credit inquiries (10%)

Scores range from 300 to 850, with scores in the 670 to 739 range considered to be “good” credit history. 

As you can see, payment history is the largest factor in determining your credit score. With that being said, it’s important to avoid late payments at all cost as this will have a largely negative impact on your credit score. On the flip side, making payments on time will have a largely positive impact on your credit score. We suggest using credit cards to pay for as much of your monthly expenses as possible assuming you have the capital to then pay that credit card off every month. Not only will this improve your payment history as it pertains to your credit score, but there are often rewards and benefits you can receive by utilizing a credit card. If you ever get to a point where you’re carrying a credit card balance, we would suggest reevaluating the use of credit cards at that point.

Your credit usage, particularly as represented by your credit utilization ratio, is the next most important factor in your credit scores. Your credit utilization ratio is calculated by dividing the total revolving credit you are currently using by the total of all your revolving credit limits. This ratio looks at how much of your available credit you’re utilizing and can give a snapshot of how reliant you are on non-cash funds. Using more than 30% of your available credit is a negative to creditors. Keeping this ratio low is going to be a large factor in increasing your credit score. 

One factor that is somewhat out of our control is the age of our credit. How long you’ve held credit accounts makes up 15% of your FICO® Score. This includes the age of your oldest credit account, the age of your newest credit account and the average age of all your accounts. Generally, the longer your credit history, the higher your credit scores. If this isn’t something you’re thinking about as a teenager or someone coming into adulthood, it may have an adverse effect on your score in the future. This is why we think it’s important for parents to help their kids understand the importance of credit and how to use it responsibly. While this isn’t a huge factor, at 15%, we still think it’s important to start using credit sooner rather than later to help build that credit score.

People with high credit scores often utilize a diverse portfolio of credit accounts, which might include a car loan, credit card, student loan, mortgage or other credit products. Credit scoring models consider the types of accounts and how many of each you have as an indication of how well you manage a wide range of credit products. 

Lastly, The number of credit accounts you’ve recently opened, as well as the number of hard inquiries lenders make when you apply for credit, accounts for 10% of your FICO® Score. Too many accounts or inquiries can indicate increased risk, and as such can hurt your credit score. Limiting how often you’re applying for lines of credit is going to help keep your inquiries low which will in turn should positively affect your credit score.

Ben Webster, CFP® and Derek Prusa, CFA, CFP®

Co-Founders and Owners of Aspire Wealth