Credit is almost a must-have today — your ability to buy a house or a new car and even your ability to rent some apartments relies on your credit score. But what exactly is your credit score? And how can you make it higher?
What is a Credit Score?
A credit score is a three-digit number that takes your past spending and repayment patterns into account to predict your future spending and payment patterns.
There are many different credit score models, but the one most institutions are interested in is your FICO score, which ranges between 300 and 850.
What Does Your Credit Score Include?
There are five major components of a credit score:
- Payment history (35% of your total credit score): FICO predicts your future long-term payment patterns based on your past payment patterns. FICO does differentiate between revolving loans (like credit cards) and installment loans (like student loans), with installment loans typically having more of an impact on your credit score.
- Amounts owed (30%): This is the amount you owe on your revolving accounts. It’s important not to constantly max out your credit cards because that will factor into this category.
- Length of credit history (15%): This has two components: the amount of time a credit account has been open and the amount of time since the account’s most recent action. The longer you consistently maintain good credit habits, the more your credit score will rise.
- Types of credit used (10%): This is the amount of different pieces of credit you have, such as credit cards, mortgages, student loans, and car loans. Don’t open all of these just to have them, but rather open accounts that you need and use them responsibly.
- New credit (10%): This includes any new accounts you open. FICO will penalize your score if you open too many lines of credit at one time because it will look like you are desperate need of funds. So space out opening new credit accounts.
How to Improve Your Credit Score
A quick internet search for “how to improve your credit score” will return tons of results, some promising to be quicker than others, some more effective than others. However, many financial blogs and advisors agree that the following are all excellent ways to improve your credit.
Always Pay Your Bill on Time
Your payment history is the largest single component of your credit score, so paying on time is absolutely crucial. Set an alert on your calendar or automate payments so that you never miss one.
Don’t Spend to the Limit
Ideally, you’ll want to spend between 10% and 30% of your credit limit, but not more than that.
If you are spending up to your limit every month, work on bringing down your spending. Rely on debit cards or cash more often and allocate your credit card to some regular monthly expenses — gas, groceries, etc. — that won’t get you above 30% of your limit.
Raise Your Limit Without Spending Any More
If you can’t reprioritize your spending so that it falls to 30% or below of your credit limit, see if you can raise your limit.
For example, if you spend $900 per month and your limit is $2000, you’re spending 45% of your limit. If you increase your limit to $3000, but you don’t spend any more, you can lower that percentage to 30%.
If you use your revolving credit often (but not too much in any given month) and pay your bills for both revolving and installment credit on time every time, your credit score will be fine. If you are having trouble getting your credit score up on your own, talk with a financial advisor to learn about your options.