October 16, 2019
Earlier this year, a senior university gymnast scored a “Perfect 10” out of 10 in a major collegiate competition. The video of her extraordinary performance has been viewed online over 58 million times.
Some years earlier, an injury had left her unable to continue as a gymnast. Yet through discipline, resolve, and newfound health, she returned to gymnastics, achieved her remarkable score, and made a lasting impression on her sport.
To make a difference in your financial health, you don’t need a perfect score. But it pays to understand why credit scores matter and how to improve yours. Even the worst scores can make a full recovery with a little time and TLC.
Before lenders make a decision to grant or deny you credit, they look carefully and closely at your credit score—it’s the heart of whether they say “yes” or “no.”
Three nationwide credit rating companies produce credit reports and credit scores: Equifax, Experian and TransUnion. A “credit report” is a record of your debts and how well you’ve paid them on time. It also contains information on closed credit accounts, bankruptcies, accounts in collections, and foreclosures. Changes in any of these may cause your score to go up or down.
The three credit rating companies calculate your “credit score” from the information on your credit report that is input into a formula. Credit scores range between 300 and 850, and a higher credit score means you’re more likely to pay back the debt. The higher your score, the easier it is to qualify for a loan and get better loan terms.
An important part of being in control of your finances is to know what’s on your credit report. If your credit report is not accurate, then your credit score is not accurate. Go to annualcreditreport.com, the government-authorized website for free credit reports, or contact the credit reporting companies directly.
Once you receive your credit report, check it for accuracy. Closely review your credit report for your name, social security number, address, credit accounts, date opened, credit limits and other pertinent information. If there is an error, submit a dispute to the credit reporting companies and the business that reported the information.
Credit rating companies are required by law to provide one free copy of your credit report each year. Strangely, there’s no requirement to provide your credit score. But obtaining your credit score is simpler and quicker than ever from a multitude of smartphone apps and websites. You can even monitor your credit report and credit score from your phone or computer. The key is to find a reliable source for your credit score and know it.
Financial information entered into the credit score formula is important, but all the data is not equally so. Credit rating companies place an emphasis on “time” in calculating your credit score. In particular, they take a close look at on-time payments and late payments for your debts. On-time payments show financial responsibility and increase your credit score. Even with late payments on your credit report, you can improve your score over time by paying your bills on time.
The other big factor in your credit score calculation is total debt load, or all the money you owe lenders from car loans, credit cards, mortgages, gas cards, and so on. The more debt you have, the greater risk you are to the issuer. They want their loan repaid with interest, and taking on too much debt can be a warning sign.
Every borrower has a limit to how much debt they can carry, which is why your debt load is an important number to be aware of. Your total debt is compared to your income when lenders consider approving or denying your application for new credit. The more debt you have, the greater it can reduce your credit score.
Besides the total debt you have, simply submitting a credit application can impact your score. To protect a drop in your credit score, refrain from taking on more debt than you can manage and resist bunching together new credit applications.
When a lender approves credit, they authorize a credit limit, the maximum they allow for a particular debt, say a credit card. The credit limit reduces some of the lender’s risk by keeping you from taking on more debt than you can pay back (see debt load above).
Your credit score is a way for lenders to evaluate how well you meet your monthly financial obligations, and if you’re approaching or have maxed out your credit limit, it’s a warning sign for lenders. As a result, your credit score may be knocked down if you get close to or have maximized your credit limit.
Keeping your debt balances low and away from your maximum credit limit demonstrates financial responsibility and can increase your score over time.
Having a history of on-time payments is part of building a good credit score. But if you have late payments or other credit mistakes, how can you boost your score?
Consider taking out a credit builder loan at your financial institution. This type of loan is somewhat of a mix between a traditional loan and savings account.
In a credit builder loan, you agree to make regular payments into an interest-bearing account, say $100 a month for 12 months. After you’ve made the 12 payments, you withdraw $1200 plus any interest the account has earned. Nothing fancy there, but making regular, on-time payments goes on your credit report and can increase your credit score. Besides, it is a good way to commit to saving money.
You can take steps to raise your credit score, even if you’ve made mistakes in the past. Gaining an understanding of your credit score and recognizing its impact is part of achieving optimal financial health.