A high credit score is a component of good financial health.
Your credit score is number between 350 and 850 that is determined by a secretive, mathematical formula created by Fair Isaac and Company aka FICO.
There are five factors that impact credit, and while the actual formulas lenders use to determine loan worthiness are not disclosed, there are five things we know impact a score.
- Debt to credit ratio
- Long history of paying on time
- Multiple types of accounts
- Length of credit history
- Last application for credit
Below are steps you can take to increase your credit score by maximizing the power of each one.
1. Debt to credit ratio
Your debt to credit ratio (D/C) accounts for 30% of your credit score. Keep it at 30% or less on all your lines of credit for the highest credit score. That means if you have a credit line of $100 (your credit, C), which is the amount you can spend or use, and what you are actually using is $30 (your debt, D), your D/C is 30%. You could spend $100 on this credit card, but that would make your D/C to 100%, which would negatively impact your credit score.
Each line of credit carries the same weight, so focus on bringing your smallest credit lines down to 30% or less if you are trying to increase your credit score fast.
For example, if you have two lines of credit: one for $100 and one for $1000. Paying that $100 line down to $30 has the same impact on your credit score as paying the $1000 line down to $300, and you’ve only had to spend $70 as opposed to $700.
2. Long history of paying on time
A long history of paying on time accounts for 35% of your credit score.
It takes six months to establish credit history if you are just starting out. The longer you have had credit, and the longer you have paid you credit lines on time, the higher your credit score will be. This is the biggest factor in your credit score at 35%, so make it a priority to pay your loans on time, every month. Looking at your statements and making automatic payments are simple way to make this happen.
TIP: To get an immediate boost to your credit score in this category, become a joint account holder on someone else’s already-established line of credit with positive payment history.
Many parents do this for their teenage children, and spouses for their significant others, however anyone can share an account with anyone. Lenders like to have more than one person responsible for payment, and a phone call is all it takes to add someone to an already-established credit card account.
Caution: when you become a joint account holder your name cannot be removed from the account until the loan is paid in full or closed. It also makes you responsible for payment and your credit score can be negatively impacted if payments are not made on time.
3. Multiple types of accounts
Having multiple types of accounts, or loans, comprises 10% of your score. In the world of credit, lenders want to see you can manage different types of loans, so you get bonus points for having a student loan, car loan, mortgage, and credit cards.
If you want to boost your score in this category, it will take time. First of all, because when you open a new line of credit you will experience a temporary drop in your score. That’s because the application for credit is considered a hard-pull inquiry and negatively impacts your score for about one to two months about 15-20 points.
After the new loan has been established and a couple on-time payments have been made, your score will resume to what it was prior to obtaining the new loan, and you will have an additional boost due to the new loan type.
Again, when it comes to increasing your credit score with this factor, note that loans cost money because of interest. Is it worth is to pay interest on a new loan to increase your score?
If the reason you need to increase your score is to get the best rate on a larger loan such as a mortgage, then it may make sense. Do the math before you decide.
4. Length of credit history
The next thing that affects your credit score is the time period for which you have had credit –this accounts for 15% of your credit score. This is different to payment history; this is the actual period of time that you have had any credit at all. You will have a higher score if you have had credit for 20 years versus if you have had credit for one year. It takes 6 months to establish credit.
One again, to maximize this category, become a joint-account holder on a long-established account. This comes with the same precautions as discussed in 2. Long History of Paying on Time.
5. Your last application for credit
Finally, your last application for credit accounts for 10% of your score. This is also known as an inquiry. An inquiry happens when someone, including you, looks at your credit.
There are two types of inquiries:
- Hard pull inquires and,
- Soft pull inquiries
A soft-pull inquiry does not affect your credit score and occurs when an existing creditor looks at your credit to view your current situation. They are looking at your high balances on credit cards, how long it took to pay them down, if you paid on time, and if you have asked for new lines of credit recently.
The reason lenders do inquiries is to determine if they want to extend more credit to you, or offer a promotion such as a 0% balance transfer. Soft inquiries also occur when you pull your own credit report.
Hard-pull inquiries occur when you apply for new credit, such as a credit card, car loan, or mortgage. These inquiries do affect your score, meaning once a hard-pull inquiry occurs, your credit score will drop about 10 to 15 points for 4-6 weeks.
TIP: A way to avoid multiple drops in your credit score due to hard-pull inquiries is to apply for credit with different lenders within a 30-day period. For example, if you are shopping for a car, visit Honda, Toyota, and BMW within a 30-day period.
While each dealership will pull your credit, it will only impact your score once, as long as each pull happens within 30 days from one another. The same strategy can be applied to home loans. If you are shopping for a new mortgage or to refinance an existing mortgage, apply with different lenders within 30 days of one another to avoid multiple drops in your score.