Thursday, February 23, 2012

How to Improve Your Credit Score

Credit scores are mysterious, confusing, frustrating, but can be rewarding.  If you have ever been confused by a credit score or wanted to know how to improve your credit score, then keep reading.  First, let’s look at how a credit score can affect you!

**You are buying a $130,000 home and want to get a 30 year mortgage.  The lender pulls your credit and you find out that your credit score is 690.  This would mean that your interest rate would be around 4.25%.  Over 30 years you would pay $230,227.87 total, $100,227.87 of this being in interest. 
**Now let’s say that you are in the same situation, but your credit score is 730.  With this score you would pay $223,430.36 over the 30 year period of time, $93,430.36 of this being in interest. 

As you can see, a difference of 40 points can cost you $7,000Credit scores matter!

What is a good credit score?

Credit Score
% of Americans with this score

How is my credit score calculated?
Most lenders use the FICO score to evaluate borrowers.  The actual formula that is used to calculate the score is considered a trade secret, but there are 5 important factors significantly impact your credit score
1.      What is your payment history?
a.      This makes up 35% of your total score
b.      Regency- How recent was your last late payment
c.       Frequency- How frequently do you have late payments
d.      Severity- How late was your late payment
2.      How much do you owe?
a.      Makes up 30% of your total score
b.      Keep the difference between your balance and credit limit at a wide margin
3.      How long have you had credit?
a.      Makes up 15% of your score
b.      The longer you have had credit, the better
4.      When was your last application for credit?
a.      Makes up 10% of your score
b.      Don’t open a lot of accounts in a short period of time
c.       Don’t open accounts right before you apply for a loan
5.      What types of credit do you use?
a.      FICO wants a healthy mix of revolving credit and installment loans
b.      Major credit cards are good for revolving credit, but you do not have to carry a balance

How do you get your score?
When retrieving your credit score make sure you go to a legitimate vendor.  Also, make sure you do not sign up for credit monitoring.  Many companies offer free credit reports, but these reports do not always include the score.  My recommendation:
1.      Go to
2.      Pay about $40 to get your Equifax and Transunion report. 
3.      Do this once a year, or before applying for credit.
4.      Pulling your own credit will not hurt your score.
5.      Having a lender pull your score when applying for credit will affect your score.

How do you improve your score?
1.      Pull your credit report
a.      Check identity information
b.      Review credit accounts
c.       Examine inquiries
d.      Look over any collections or public records
                                                              i.      Chapter 13 bankruptcy stays on your credit bureau for 7 years
                                                            ii.      Chapter 7 bankruptcy—10 years
                                                          iii.      Lawsuits, judgments, or paid tax liens—7 years
                                                           iv.      Late payments—7 years
                                                             v.      Any negative information that is not yours
2.      Pay your bills on time
3.      Pay down debt
a.      Pay down debts that have balances close to the credit limit.
b.      Pay the debt down to around 30% of the limit and move to the next card of revolving credit line.
4.      Don’t close revolving debt accounts
a.      This will rarely help you!
b.      You never want to narrow the gap between credit available and balance owing. Instead, you want to widen this gap by paying down balances.
c.       Closing these accounts could also make your credit life appear younger than it is.
5.      Apply for credit sparingly
a.      If you don’t have credit, a credit card is a good place to start. 

Credit scores may still seem very confusing to you, but I hope this explanation helps clear up some issues.  The information for this post was primarily taken from Your Credit Score: How to Fix, Improve, and Protect the 3-Digit Number that Shapes Your Financial Future by Liz Pulliam Weston.  For more information, this is a great book to get at your local library or bookstore.  Another good resource on credit score information is a Youtube video titled Understanding Credit Scoring.  

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