Table of Contents
A good credit score unlocks a wide variety of financial opportunities, including easier and cheaper access to credit and loans, reduced insurance premiums, better lease agreements, fewer utility deposits, and even potential employment opportunities. In our modern economy, your credit matters more than ever before, and you should take every opportunity to improve your credit score and capture these potential benefits.
This article is designed to help individuals move from average credit to excellent credit. If you have no existing credit history, the information in my credit building guide will help you get started. If you have poor credit, please see my credit repair guide before returning to this article.
Before attempting to increase your credit score, you need to know where you stand. There are several different websites and financial products that will allow you to check your credit score for free. Use one of these free methods to obtain your most recent score, and write that number down so that you can accurately evaluate your credit score improvements over time.
Understanding How to Improve Your Credit Score
When thinking about ways to increase your credit score, you should first understand how your score is calculated. Private companies use credit scoring algorithms to analyze your credit reports and automatically generate your credit scores. There are numerous different credit scoring models in existence, but FICO is by far the most important, being used in roughly 90% of all lending decisions.
Although FICO doesn’t release their exact credit scoring algorithm, they do provide a basic breakdown of the credit scoring factors that are included in their model.
These five credit factors provide a framework that can be used to raise your credit score. The remainder of this guide will break down the most productive credit-building strategies within each factor.
Payment History (35%)
Payment history is the factor most heavily weighted by FICO and most other credit scoring models. Intuitively, this makes sense because all creditors are concerned about your ability and willingness to repay outstanding debts. If you have a history of missed payments, it is reasonable for a creditor to expect that behavior to continue.
There aren’t any magic solutions to correct a poor payment history. If you are currently late on payments, you can bring most accounts current by repaying the outstanding debt. Assuming the late payments are not a recurring problem, many creditors will agree to remove the late status from your credit report. Send the creditor a goodwill letter, which offers an explanation for the late payment(s) in question while requesting that the creditor delete the late payment status on your credit report.
If you continue to ignore the problem, many creditors will charge-off your account and sell your debt to a collection agency. If you are in this situation, my guide to rebuilding credit offers a number of suggestions that can be used to negotiate a settlement and possibly have the account deleted from your credit history.
Once you have attempted to correct any past mistakes, you can build a positive payment history by automating monthly payments on all forms of debt. By paying your monthly balance in full each month, you will eliminate any possibility of missed payments while avoiding interest charges and fees.
Credit Utilization (30%)
Credit utilization, also called amounts owed, is the percentage of available credit being used at any given point in time. If you make a $2,000 purchase on a $10,000 credit limit, you are utilizing 20% of the available credit.
The credit utilization for each individual account matters, but your total credit utilization across all open accounts is more important. Furthermore, revolving lines of credit (credit cards) are more heavily weighted in the utilization ratio than installment loans.
FICO and other credit scoring models officially recommend that your credit utilization remains below 30% for each individual account, but you will see additional credit score improvements if you maintain an overall utilization ratio of 10% or less.
To reduce your credit utilization, you have three options:
1) Reduce your debt balance
In the example above, I suggested that spending $2,000 on a $10,000 credit limit would result in a 20% utilization ratio. It’s not quite that simple. Creditors almost always report your credit information once per month around the time when your monthly statement is generated.
If you make a $2,000 purchase, and then immediately make a $2,000 payment, the entire sequence of events will probably never be reported to the credit bureaus (unless the timing aligns with your monthly statement). You can use this information to strategically reduce your credit utilization on each account.
For example, if you have multiple credit cards, you can repay the entire outstanding debt balance (before the statement generates) on most accounts, while leaving a small balance on one (or several) other accounts. By showing a small balance on your monthly statement, you are automatically following FICO’s official recommendation that you maintain low credit utilization over time: “… a low credit utilization ratio will have a more positive impact on your FICO Scores than not using any of your available credit at all.”
To summarize, a 0% utilization ratio is just fine, but showing a few dollars on your monthly statement is slightly better. More importantly, using less than 30% of the credit available on any account is highly recommended by all credit scoring models.
2) Increase existing credit limits
Increasing the available credit limit on any of your existing credit accounts will decrease your overall credit utilization. Most creditors will allow you to request a credit limit increase if your account is in good standing, and some will offer an automatic credit limit increase after a period of responsible usage. The key difference is the potential for a hard credit inquiry.
If the creditor offers you a credit limit increase, it will never result in hard credit inquiry. But if you request the increase, many creditors will pull and review your credit, resulting in a hard inquiry on your credit report. These hard credit inquiries do impact your credit score a small amount, as discussed in the “New Credit” section below.
Instead of requesting a credit limit increase, you might consider applying for another credit card. Both actions typically result in a credit pull, so you might as well open a new account to collect any potential rewards in the process.
3) Apply for new lines of credit
Opening new accounts will increase your total available credit, decreasing your overall credit utilization ratio.
If you are struggling to reduce an existing credit card balance, you can actually transfer the debt to a new card offering 0% interest, something known as a balance transfer. Because the new account will offer a new line of credit, you can reduce your utilization ratio and the interest rate on your debt at the same time.
If you don’t need to transfer existing debt, you can open a new credit account and collect a variety rewards in the process. There are dozens of available credit cards, so you might narrow your search by focusing on the rewards that interest you. Are you interested in earning cash back, or airline miles, or hotel points, or generic travel rewards?
Credit History (15%)
Your credit history includes the age of your oldest account and newest account, the average age of all accounts, and the length of time since open accounts have been used.
Other than building credit at an early age and occasionally using your open accounts, there are very few actions that will improve this credit factor.
Credit Mix (10%)
FICO and most other credit scoring models recommend a combination of revolving credit (credit cards) and installment credit (most loans).
With regard to credit cards, the discussion in the “Credit Utilization” section above should help you get started.
Installment loans include any type of mortgage, auto loan, student loan, personal loan, business loan, and most other loans that require a regular monthly payment. If you already have one of these accounts open, there is no reason to establish another. If you’ve never established one of these loans, you can establish a credit-builder installment loan very easily and cheaply online.
New Credit (10%)
New credit includes the number of hard credit inquiries and new accounts listed on your credit report. According to FICO, “…opening several new credit accounts in a short period of time represents greater risk – especially for people who don’t have a long credit history.”
FICO’s suggestion is that opening too many accounts in a short amount of time will have a small negative impact on your FICO score, as will having too many recent credit inquiries. But the more important question is, how does FICO define an excessive number of new accounts?
The truth is, it’s impossible to know. Based on my own personal experience, I don’t think you should be worried about searches for new credit. First of all, hard credit inquiries only impact your credit score for 12 months, and even during that time, the effect is small. If some of your credit inquiries result in new accounts, you will experience a decline in your average age of accounts (a factor in your credit history). But this too is unimportant, because new accounts eventually become old accounts, which will ultimately age your credit history and increase your credit score.