Overview
So you are ready to start focusing on building your credit score.
Maybe you want to get a new car, a nice rewards credit card, an apartment or purchase a home. Your credit score affects these goals. The better (higher) your credit score, the more favorable the credit terms you can get.
A good credit score allows you to get lower interest rates on your big ticket purchases, your credit cards and all other credit facilities. Hence, this can save you hundreds or even thousands of dollars on your purchases and over time.
What is your credit score?
Your credit score is a measure used by financial and other institutions to determine your creditworthiness. Creditworthiness is the determination of a person’s or company’s suitability to obtain financial credit, and their anticipated ability to repay.
The higher your score, the better your creditworthiness is determined to be. Credit scores are based on various pieces of information reported to the three main credit bureaus: TransUnion, Equifax and Experian. These bureaus use this information to compile your credit report.
Credit scores range from 300 to 850. The ranking of your score levels differ between various institutions. Generally the ratings are as follows:
- 800 to 850: Excellent or perfect
- 750 to 799: Very good
- 700 to 749: Good
- 650 to 699: Average
- 600 to 649: Below average
- 300 to 599: Poor
Factors impacting your credit score
There are several factors which impact your credit score. These factors, and their general weighting in terms of impact to your credit score, are summarized as follows:
- Payment history – 35%: Your payment history records how you have made payments against your debt obligations. This is the most heavily weighted factor as financial institutions assess your repayment risk. Hence, a single missed payment can have a significant negative impact to your credit score. Your payment history can stay on your report for up to seven years. Therefore missed payments can have a long lasting impact.
- Amount of debt – 30%: The overall amount of debt that you carry can have an impact on your credit score. More specifically, your utilization of revolving credit lines, including credit cards. Your utilization is the amount of your available credit which you are currently using. For example, if your credit card limit is $1,000 and you have an outstanding balance of $600, your utilization is 60%. Lower utilization rates indicate to lenders that you are potentially a responsible borrower. This is because you do not appear to be reliant on your credit line. You should aim for a utilization rate below 30%.
- Length of credit history – 15%: This aspect focuses on the average age of your credit history. The longer your credit history, the more favorable the impact on your credit report. It is important to note that this factor takes the average age across all of your credit accounts. As a result, each time you open a new account, the average age of your credit history is reduced.
- New credit accounts – 10%: Each time you apply for a new credit facility, the lender will likely perform a hard inquiry on your credit report. Too many hard inquiries may signal to creditors that you are desperate for access for credit. Consequently, this could result in you being assessed as a higher risk customer. Hard inquiries remain on your credit report for approximately two years. Their impact however subsides over time.
- Credit mix – 10%: The credit mix refers to the different types of credit accounts that you have on your credit report. Various types of accounts include revolving debt, including credit cards, auto loans, personal loans, mortgages, etc. Lenders view your ability to responsibly manage different types of accounts as a favorable factor.
Steps to increase your credit score
Now that we have gone over the composition of your credit score, let’s look at some ways to increase your score.
If you are starting from scratch, the first thing you will want to do is to obtain a secured credit card. You secure these types of credit cards with a cash deposit and they generally provide you a spending limit of $300 to $500. You will then ensure that you carry a balance of no more than 10%-20% of the card’s limit, and ensure that this balance is paid off ON-TIME every month. Also, please refer to our article on using credit cards responsibly.
After three to six months of responsibly using your credit card, you will have a credit score. This score may be around the average range. As the next step, approach your financial institution for a small personal loan of $500 to $1,000 to be repaid over a 12 to 24 month period. It goes without saying that you should make these payments regularly and ON TIME each month. The purpose of this loan is to add some “depth” to your credit file.
The above steps will hit on all of the main factors which impact your credit. After keeping these accounts in good standing for several months, your credit score will gradually increase over time.
In summary
Achieving a good credit score takes time, dedication and discipline. Here are a few key points to remember:
- Firstly, a good credit score can save you a significant amount of money over the course of your life and personal finance journey.
- It can open doors and provide opportunities that may otherwise not be available.
- Pay your bills on time, every time! Even if you are only able to make the minimum payment.
- Keep your credit card and line of credit balances to no more than 10%-20% of the credit limit.
- Limit hard inquiries on your credit report by only applying for credit that you actually need.
Managing your credit score is a part of your overall personal finance journey and responsibilities. Refer to our article on budgeting which can help you to stay on top of your personal finances.
Lastly, good luck, and stay focused! We can get to the “800+ club” together!
Disclaimer
The information detailed above is based on my knowledge, personal experiences and research. These views are my own and are not personal professional advice.
