A person’s credit score is one of the factors that lenders consider when they extend a line of credit or loan (for example, an auto loan, mortgage, or personal loan). Lenders often use your credit score to determine interest rates, lending terms and loan risk. FICO and Vantagescore are the most widely used credit scores and range between 300 and 850. From a lender’s perspective, a higher score equates to lower risk, which often translates to more favorable credit terms and better interest rates.
The following factors account for a consumer’s credit score:
- Payment history – which shows whether or not you pay your bills on time. A single late credit payment can negatively affect your score.
- Credit utilization rate – measures how much credit you use in relation to your available credit limits. For instance, if you have two credit cards with a combined limit of $10,000 and a combined balance of $4,000, your credit utilization ratio is 40%. The lower your ratio, the better your credit score.
- Length of credit history – shows how long you've had credit. Generally, the longer you've had access to credit, the more positive the impact on your credit score.
- Type of credit – using different types of credit, (for example mortgages, credit cards, and personal loans) indicates how well you manage your credit. A more diversified pool of credit is better for your score.
- New credit – opening a number of new accounts in a short period of time has a negative effect on your credit score. Lenders examine how often you apply for credit by looking at the number of “hard inquiries” on your account. (Checking your credit report doesn't generate a hard inquiry, which means it doesn't impact your score.)
Improve Your Credit Score
The first step to improving your credit score is reviewing your credit report. You can obtain a free copy by visiting AnnualCreditReport.com or calling 877-322-8228. Your credit report includes the following information:
- Credit history – both the number and types of credit you have, both active and closed accounts, how long you've had the accounts, your account balances, and your payment history.
- Credit inquiries – which is the number of times you've applied for credit. These inquiries will show up on your credit report for up to two years.
- Collections – which include unpaid or overdue debts, like foreclosures, bankruptcies or liens.
Once you receive your report, determine if there are any errors. If you find any mistakes, you have a right to dispute the information. You can do so by contacting the three credit reporting bureaus: Equifax, Experian, TransUnion.
In addition to correcting any mistakes, determine what you need to improve. Typically, you want to focus on:
- On-Time Payments – Even if you cannot pay off a loan immediately, always ensure that you make your payments on time. Consider using automatic payments or calendar reminders to help you remember. Note that paying off a collection account will not automatically remove it from your credit report. It will remain for up to seven years, so it’s important not to reach collections if possible.
- Low balances – your credit utilization is an important factor in calculating your score. Lenders prefer seeing rates below 30%.
- Applying for new credit only as needed – Too many inquiries that result from applying for new credit will lower your score.
- Maintaining your accounts – It might be a good idea not to close your credit card accounts, even when if stop using them. Closing an account can have a negative impact on your length of credit and on your credit utilization ratio, both important factors for determining your overall score.
If you need assistance, contact a professional credit counselor at the National Foundation for Credit Counseling or similar organization.
The views, information, or opinions expressed in this article are solely those of the author and do not necessarily represent the views of Citizens State Bank and its affiliates, and Citizens State Bank is not responsible for and does not verify the accuracy of any information contained in this article or items hyperlinked within. This is for informational purposes and is no way intended to provide legal advice.
