Banks and financial institutions use credit scores to make determinations regarding a consumer's credit risk. Employers, landlords, and insurance companies use credit scores in building a picture of how responsible you are. The higher the credit risk the higher the interest rate you will be charged. A FICO Score of 740 or above is considered excellent and will qualify you for the best rates. A score of 650 or lower will result in the highest interest charges for credit, if you qualify at all.
Fair Isaac, the originator of the FICO Score, uses weighted components to calculate individual credit scores. Credit Scores are calculated as follows: Payment History accounts for approximately 35% of one's credit score, Amount Owed 30%, Length of History 15%, New Credit 10%, and Type of Credit Used 10%. By knowing which components are weighted more, you can develop a plan to attack the root causes of your low credit score and see improvement faster.
Paying Bills on Time Should Be Your Top Priority
Since 35% of your credit score is based on payment history, your immediate priority must be making on-time payments your top priority. If you have struggled to be on-time paying your bills, you may want to consider signing up for automatic bill pay. Once you enroll, you can take comfort in knowing that you will never be charged late fees again, nor will your credit score be dinged.
If you are bouncing checks and this is the reason you are late on paying bills, one quick fix is to request the due dates on bills be changed to move them closer to your pay dates. This strategy will eliminate late fees and the negative mark on your credit score as well as provide an albeit artificial, mechanism to curb overspending before bills are paid.
Focus on Paying Down Debt to Improve Credit Score
A credit utilization ratio of 30% means you are using 30% of your available credit. Anything above 30% will cause your credit score to drop. By paying your bills on-time you are building a payment history that will eventually improve your credit score as well as lowering your credit utilization ratio.
There are many ways to free up cash to put towards paying down your debt. As with any financial move the first step is to get a clear picture of what your finances look like currently. Identifying where your money is going will enable you to quickly identify areas of spending that can be trimmed so that the savings can be diverted to paying down debt. Discretionary spending like eating out, vacations, clothing, entertainment, etc. are good places to start cutting back.
Other Ways to Improve Your Credit Score
If you already have a fair to good FICO credit score and have a good payment history, you may want to consider opening a second credit card. Opening a second credit card will increase your available credit which on the flip-side will cause your credit utilization ratio to go down. Start using the credit card and paying the balance off each month, this will be reported to the credit bureaus and you should see an improvement in your credit score due to the lower credit utilization ratio. Keep in mind that a new credit card will also cause the average age of your accounts to go down which would have a negative impact on your credit score however, by paying off balances each month and keeping your credit utilization ratio to no more than 20%, you will see continued improvement in your credit score.
Pulling a credit report and correcting any mistakes should be a regular part of your yearly financial routine. By catching and fixing errors in a timely manner, damage to your overall credit profile can be minimized. Using a credit service can help resolve more complicated credit disputes, alert you to changes or updates to your credit reports, and help protect your assets from identity theft.