How To Improve Your Credit Score

Good news for the country: The average credit score is at a record high of 704. That’s according to the Fair, Isaac Corporation, the company that produces the most commonly used credit scoring product in the U.S. today, the FICO Score. If you’ve had credit issues in the past, or if you are simply new to the credit world, there are ways to improve your credit score. 

The FICO score, like most credit scoring systems, seeks to quantify for lenders the probability that you will fail to make agreed-upon payments on a loan. Scores range from 850 for pristine credit down to 350 for those few people who are defaults waiting to happen.

Overall, seeing Americans’ credit scores improve overall is very good news. It means that Americans are generally in better financial shape than they used to be, with higher employment rates and steadier incomes.

But it’s a mixed blessing for people with credit scores well below the national average. Here’s why:

When the average credit score goes up, your competition is getting tougher. If your credit score is in the mid 600s or below, and there’s a chance you may want to borrow money (or rent an apartment, or apply for a job) in the future, you’re going to have to up your game.

How to improve your credit score

Get organized.

The most important single thing you can do to improve your credit score is to pay your bills on time.

Easier said than done, right?

But the fact is that your track record of making on-time payments to creditors and utility companies is the most important factor in your credit score. This one factor accounts for 35%of your credit score, according to FICO officials.

Factors Affecting Your FICO Score

  • Your payment history: 35%
  • Amounts owed: 30%
  • Length of credit history: 15%
  • New credit: 10%
  • Credit mix `10%

It’s one thing if you’re perfectly organized and you just don’t earn enough to cover your bills at the end of the month. But few of us are perfectly organized. And if you significantly improve your organization skills, your income is probably going to go up in short order, as well.

To make sure you don’t miss any more bills, take some or all of the following steps:

  • Automate your bill-paying, using your bank’s bill paying service. Nearly all major banks support this via their websites.
  • Set up a single dedicated spot in your home for bill paying.
  • Sign up for email notifications for all your bills. As they come in, change the subject line to specify the vendor, date due and the amount, and forward the notifications to a dedicated email address you use only for that purpose. Every week or two, go through all your notifications and pay them, or ensure they’ve been paid via automated processes. If you pay manually over your computer,
  • Use calendar reminders for key bills, and when they’re due. If you use Outlook, Google Calendar or a similar calendar, set an alert for a couple of days before any big due dates or bank drafts so you aren’t taken by surprise.
  • Schedule a set time each week dedicated to taking care of bills. Put it on your calendar and stick to it.
  • Organize your bills according to their due dates.
  • Changed banking accounts or debit card numbers? It’s a simple matter to go back through your last couple of months of transactions in your bill-paying email account and your stack of bills organized by the due dates and update them all to your new account, so you don’t miss a payment because of the bank change.

Reduce your debt and your monthly payments. Preferably both.

Get your credit utilization ratio down.

Your credit report will show all the money you owe to all the creditors who report your account to the major credit bureaus, as well. Your credit score takes into account a metric called your credit utilization ratio. This is your total debt dividend divided by your total available credit.

For example, if you have a total credit line of $10,000, and you owe $3,600, your credit utilization ratio is 36%.

FICO officials recommend using no more than one-third of your available credit at any one time, and a ratio of 10% or lower is even better.

Note that using your card a lot and then paying it off in full every month may maximize your rewards and cash back incentives. But even if you pay off your card every month, you still may have a high credit utilization ratio. That’s because the system just takes a “snapshot” of your accounts once each month. If it happened to take its snapshot right before your payment, you could still have a very high credit utilization ratio.

To improve your credit score, it may make sense to make your credit card payments several times per month or at least make sure you zero them out just before the statement close date, which is when the banks generally send balance information to credit bureaus. Better yet, just use them to buy gas or pay your phone bill, let them ply you with rewards and incentives, and then pay the balance each week.

Also note that the system tends to favor keeping credit accounts open, and taking credit limit increases when offered — and then not using them.

Lower your debt-to-income ratio.

The FICO system can’t see your income. They don’t know how much you earn, so they can’t calculate a debt-to-income ratio. But it’s still a key metric, and can make all the difference between getting approved or rejected for a mortgage, car loan and even an apartment. 

Your debt-to-income ratio is the ratio of all your monthly payment obligations divided by your gross monthly income.

Mortgage underwriters calculate a ‘front-end’ ratio and a ‘back-end’ ratio, with the front-end ratio including.

Front-end ratios

Your front-end ratio is a measure of your housing expenses in relation to your income. To calculate the front-end debt-to-income ratio, add up all your housing expenses and divide it by your gross monthly income. For instance, if all your housing-related expenses total $2,000 and you earn $6,000/month, before taxes, your front-end DTI is 33 percent.

That would be a bit high: Most mortgage lenders want to see a front-end ratio of 28 percent or less. That is, to qualify for the best loan programs, you should be paying not more than 28 percent of your gross monthly income on housing. Some experts recommend keeping rent payments under 20 percent of gross income, if possible.

Your back-end ratio

To calculate your back-end ratio, add up all your total debt obligations for the month. This includes not just housing, but also credit cards, alimony, and car payments. Then divide the total by your monthly pre-tax (gross) income.

You’ll notice that this metric relies on the amount of your monthly payments, not your total debt amounts. This is an important distinction. To get the maximum benefit on your FICO score, you must strive to reduce the dollar amount you pay out each month. 

This means that for some kinds of debts, you won’t get a credit score “bump” until you actually pay off the balance in full.

Example: If you have a car loan of $10,000 at $300 per month, and you pay it down to $1,000, your credit report will still show a $300 per month payment.  This counts directly against your debt-to-income ratio. This is because these payments remain level even as you pay the balance down. 

With credit card debt, in contrast, paying down your principal generally also reduces your minimum payment. 

All things being equal, it makes sense to eliminate higher-interest and non-tax-deductible debt first. But if you can quickly knock out entire payments from your monthly budget, by all means, do so. This is a quick way to give your credit score a boost while still improving your overall financial situation. And you’ll free up that entire payment to go toward higher interest debt the following month. 

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