4. Going Forward — How to Improve Your Credit Score

While you're focusing on lowering balances, it's also important to make a few key moves to start improving your credit score, which may help you qualify for lower interest rates over time.

Your credit score and credit report are key tools that measure your financial risk, giving lenders a way to predict how likely you are to pay your bills on time. Many lenders — and others — use your credit score to help determine whether or not to give you a line of credit, whether you're applying for a credit card, buying a car or planning to buy a home. The higher the score, the lower the risk and the lower the interest rate you'll usually be offered.

Your credit record may also affect your ability to get a job and find affordable insurance. So it's always important to build — or rebuild — a good score…even if you aren't about to take out a new loan.

BBB Tip: Credit Reports

Check your credit report for errors or potential fraud once each year. You can order a free copy of your credit report from each of the three credit reporting agencies once every 12 months by visiting www.annualcreditreport.com. This site is run jointly by the three credit reporting agencies (Equifax, Experian, and TransUnion).

It’s a good idea to stagger your requests for a copy of your credit report, requesting it from one bureau every four months. This will help you monitor your credit over the course of a year and detect potential fraud early.

How Your Score Is Calculated

There are several types of credit scores, but lenders often use the FICO score, which ranges from 300 to 850.

Your FICO score measures five key criteria and can vary slightly, based on which credit reporting agency issues the score. The information that shapes these criteria comes from your credit report, and includes:

  • Length of credit history
  • Types of credit lines
  • Payment history on those credit lines
  • Amounts owed on those credit lines
  • New credit lines — how many and over what period of time

Case Study: A High FICO Score Can Translate Into Big Savings

Let’s say the average lender was offering a 30-year mortgage at a 4.743% interest rate for borrowers with a FICO score between 760 and 850. But the average lender charged a 6.332% interest rate for borrowers with a FICO score between 620 and 639.

Impact of FICO Score on Payment — On a $250,000 loan, that monthly payment for borrowers with the higher FICO score range would be $1,303…versus $1,533 for those in the lower FICO score range. That’s a difference of nearly $90,000 in interest payments over the 30-year life of the loan!

For more information and a calculator to run your own numbers, visit FICO’s consumer web site at www.myfico.com

How to Improve Your Credit Score

  • Fix any errors on your credit report.
  • Get a free copy of your credit report at www.annualcreditreport.com
  • If you find any mistakes, contact each of the three credit reporting agencies
  • Pay your bills on time.
  • On average, more than one-third of a credit score is based on payment history. The later you are, the more points you lose. If you've missed payments, get current…and stay current.
  • Keep your credit card balances low.
    • Generally another one-third of your credit score is based on the amounts you owe, often expressed as your “credit utilization ratio,” which is the percentage of your credit limit that you've actually used. If you're close to the limit, it's a flag to potential lenders that you're maxing out your cards.
    • It's a good idea to keep your purchases to less than 25% of your credit limit at any time, even if you pay off your bill in full every month.

    BBB Tip: Automatic Electronic Payments

    Consider activating an automatic electronic payment schedule with your bank, so you’ll never be late for a payment.

    NOTE — Some lenders have recently increased their minimum payment requirement from 2% to 5% of the outstanding balance to 5%. If you’re only paying the minimum balance due, make sure your lender has not increased its minimum payment requirement.

    It’s a good idea to have the automatic payment pay much more than the minimum. You’ll owe less in interest and can pay down your balance much faster.

  • Limit the number of credit cards you open…including retail store cards.

    • Generally, the length of your credit history accounts for 15% of your credit score. Opening several new cards within a short period of time can hurt your score, because it lowers the average age of your accounts. Lenders worry that you plan to borrow money you may not be able to repay.
    • It's usually a good idea to keep open old cards with a long credit history, which also helps your credit score, because they contribute to your “credit utilization ratio.”
    • If you determine you want to close old cards, close them one at a time over a period of time. But, choose carefully, because the oldest may be important to a better credit score.
  • Promptly pay any traffic or parking tickets or library fines.
    • If the bill ends up going to a collection agency, your credit score could drop by as much as 100 points.
    • Pay these bills on time, and keep records of the payment.