Having a strong credit score ranks highly within one’s financial health as a standard. If going for a new mortgage, car loan, or credit card, your credit score is one of the numerous aspects lenders consider to determine whether you qualify for their service and what interest rates you will have. A higher score will also help save money in interest and potentially improve the chances of getting certain terms or even jobs and insurance related to the loans.
Many however do not realize that building and even maintaining a good credit score is not just given. In this guide, we’ll help you understand which steps you need to take in order to build and sustain a reasonable credit score while also providing you with tips on the most common mistakes to avoid.
1. Understand What a Credit Score Is and How It’s Calculated
In order to begin working on establishing a perfect credit score, it would be helpful first to define what it is and how it is derived. The credit score can be defined as a three-digit number which summarizes the credit history of an individual, in other words, his or her ability to pay back debt. A credit score can vary from 300 to 850, where a score of 700 or higher is acceptable and a score of 750 or higher is regarded as exceptional.
Your credit score is calculated using several factors, each with a different level of impact:
- Payment history (35%): This is the most important factor. Lenders want to know if you’ve paid your bills on time. Late or missed payments can have a significant negative effect on your score.
- Credit utilization (30%): This measures the amount of credit you’re using relative to your credit limits. It’s generally recommended to keep your credit utilization below 30% of your available credit.
- Length of credit history (15%): The longer your credit history, the better. This includes how long you’ve had credit accounts and how long it’s been since your last activity on each account.
- Types of credit used (10%): Having a mix of different types of credit, such as credit cards, personal loans, and mortgages, can positively impact your score.
- Recent inquiries and new credit (10%): Applying for too much credit in a short period of time can hurt your score. Each inquiry into your credit can lower your score slightly, so be cautious when applying for new credit.
2. How to Build a Strong Credit Score
If you’re just starting out or working to improve your credit, it’s important to adopt good credit habits from the beginning. Here are steps you can take to build a solid credit foundation.
Start with a Secured Credit Card or Credit-Builder Loan
If you have little to no credit history, one of the easiest ways to start building credit is by using a secured credit card or a credit-builder loan.
- A secured credit card requires you to put down a deposit that acts as your credit limit. For example, if you put down $500, your credit limit is $500. Use the card responsibly, pay off the balance in full each month, and your activity will be reported to the credit bureaus, helping you build credit over time.
- A credit-builder loan is a small loan where the money you borrow is held in a bank account while you make payments. Once you’ve made all the payments, the money is released to you, and your on-time payments are reported to the credit bureaus.
Both of these options are great for individuals with no credit or those looking to rebuild their credit after a financial setback.
Make All Payments on Time
Everyone is aware that the most outstanding factor that contributes to the score is the payment history as noted before. In order to establish and maintain a robust score, it is imperative to always be punctual in payments of all amounts owing. This means paying up all credit card dues, loans, utility bills, and any other financial obligations people have.
A single defaulted payment may be the dead weight of a consumer for nearly seven years and it will most likely be a considerable hit on the credit score. These factors lead to the questions: how to prevent oneself from missing a payment? The most sensible solution is to use autopay triggers or reminders on a calendar in order to ensure someone never misses the due date for any payment.
Keep Credit Utilization Low
Keeping your credit utilization low is another essential component of boosting your credit score. This refers to the amount of credit you actually borrow as a percentage of your total credit limit. For instance, out of a credit card limit of a thousand dollars, you should only utilize three hundred dollars or less, which is 30% of your limit.
Overreliance or frequent over-leveraging of credit sources can be detrimental to your repayment history and the credit score will be negatively impacted no matter how good the repayment habits are. As a rule of thumb, the utilization should not exceed 30% and preferably 10% should be targeted.
Avoid Opening Too Many Accounts at Once
It may be a good idea to be open to the possibility of additional credit cards or even loans for those who intend to build their credit score over time. However, too much potential credit accumulated in a short time frame can also be considered a negative by lenders. When an application for credit is made, the creditor has to look at the individual’s history for any other credit scores, called a credit inquiry, which can make the score drop for a period of time, so it should be avoided as this potential sets a bad precedent.
Building several credit accounts at the same time is not recommended, rather, work towards establishing a few accounts for a longer period. Allow time for the credit history in order for it to be beneficial when calculating the score.
Become an Authorized User
If you are an individual who is new to taking out loans or is looking to improve your credit score, then adding yourself as a user on a credit card of someone who has already established credit will make sense. This is especially true in family situations where one is added as an authorized user to someone’s account, and such a person can take advantage of that account’s good payment record and low utilization without making any payments themselves.
This is a method that can help people build credit, but it’s very important to ensure that the primary card holder has a good score because they will be able to affect your score with their behavior.
3. How to Maintain a Strong Credit Score
Once you’ve built a strong credit score, maintaining it requires ongoing attention and good financial habits. Here are steps you can take to keep your score high and protect your credit health.
Monitor Your Credit Report Regularly
One of the best ways to maintain a strong credit score is by monitoring your credit report regularly. By law, you’re entitled to a free copy of your credit report from each of the three major credit bureaus (Experian, Equifax, and TransUnion) every 12 months through AnnualCreditReport.com.
Reviewing your credit report can help you spot any errors or suspicious activity that could hurt your credit score. If you find an error, you can dispute it with the credit bureau to have it corrected.
Maintain Long-Standing Accounts
It is vital to know that the history of your credit is essential in calculating your score. This may also explain the lack of the drives your credit card is intended for since closing a credit card account that has been in use for years may affect the score negatively. However, not utilizing a credit card doesn’t necessarily end up being a negative aspect as having the account open helps increase the average age of credit accounts with the added benefit of having available credit that can aid in utilization ratio.
If you plan on closing an old account that you very rarely use, think about leaving it open, it may do your credit score a favor. If there are no annual fees associated with it, it wouldn’t make sense to close it anyway.
Limit Hard Inquiries
As we discussed above, hard inquiries made via phone calls from applying for credits can take off quite a few points off the score for a while. This is another reason though that few inquiries on a single person are unlikely to damage the score significantly, but too many of them over a brief period of time drive up the chances of the lender considering the person to be a higher risk borrower. In summary, in order to preserve your score restrain from making new applications and only seek out credit when absolutely necessary.
Keep Credit Utilization Consistently Low
Similar to how keeping your credit utilization as low as possible when first building your score is important, maintaining it also requires the same level of credit responsibly. Try to keep your credit utilization below thirty percent, even when your income level rises or higher credit limits are placed on you. This sends a message to your lenders that you have an acceptable level of credit management as well as help one’s score from movements.
Avoid Late Payments at All Costs
It is difficult to rebuild one’s credit after a series of missed payments, so timeliness should be treated as paramount. Set reminders, pay bills automatically, or make a mental note to settle any due amount before its deadline. On occasions, if you are unable to make payments, it is advisable to inform your lender or credit card provider to see if they can assist with flexible provisions like an extended payment plan or delaying the payment due date.
Final Thoughts
A strong credit score has a positive impact on your financial standing and is essential for getting loans and lines of credit. This is because a good score makes it easier for you to borrow funds without excessive interest payments. Knowing how your credit score is calculated, using credit responsibly, and checking your score on a regular basis will go a long way in ensuring your score does not drop and it works in your favor.