How to Improve Your Credit Score

For many of us, our credit score is the number that we didn’t even know we needed to manage, until it’s too late. We wait helplessly as lenders pull our credit history to determine where to set the interest rate on our loan. Bad credit can hurt our future finances by increasing interest rates on credit cards and mortgages, a frustrating cycle that can result from too much debt, a spotty payment history, credit cards that have unpaid balances, and even student loans.

So - what can we do to improve our credit score? First, we need to understand that a credit score is a number intended to summarize our creditworthiness, or the likelihood that we will pay back money loaned to us from a bank or other institution. Our score is based on our credit report information, which is typically maintained in the United States by three major credit bureaus: Equifax, Experian, and TransUnion. Our score can impact the interest rate on our credit card or mortgage, whether a landlord decides to rent to us, and even our employment. (While employers can’t check an applicant’s credit score, they can access a credit history, or report, as part of pre-employment screening.)

The concept of a credit score was introduced as an effort to take bias out of lending. Before credit scores, lenders made character-based decisions. Stores and banks would determine which individuals they deemed worthy of credit. This system resulted in discrimination against women and people of color, who were often deemed risky (and therefore unworthy of credit) against the highly subjective standards of the day.

Statisticians Bill Fair and Earl Isaac worked to create a more objective, mathematical model to assess creditworthiness. Their score, the FICO Score, was developed by Fair Isaac Corporation, and is now the most common method used to calculate your credit score. However, the score - first introduced in the 1950’s - wasn’t widely used until the 1970’s, when modern credit reform legislation started to even the playing field in regard to credit access.

Today, credit scores range from a low of 300 to a high of 850. Generally, a score below 550 is considered bad, 550 - 649 is poor, 650 - 699 is fair, 700 - 749 is good, and a score above 750 is considered excellent.

If your score falls in the “bad” or “poor” categories - below 650 - you may have difficulty accessing credit, and may be charged very, very high interest rates. Similarly, if you are above 700 in the “good” or “excellent” categories, lenders will be very eager to do business with you.

There are other scores like the VantageScore, but they tend to be used less often and are generally in line with your FICO score. I recommend focusing on your FICO score as your primary measure, though you may also want to access other scores if you have the time to do so.

So, what should you do if your score is lower than you’d like? Follow my step-by-step guide below to start improving your credit score.

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Know your score. First, you need to know your score. You can pay for your score via the three major credit bureaus. When accessing your score, be careful to avoid ongoing “credit monitoring” offers - these offers are often served up to you automatically when you are pulling your score. As you check out, ensure that you’re only paying to pull your score, and not signing up for repeat charges. If your score is lower than the “good” or “excellent” categories, you may consider prioritizing areas for improvement.

Pull your credit report. Your credit report includes the data that contributes to your score, so ensure that you have a recent copy of your report to help you analyze your score. While legislation in the U.S. allows you to pull a free credit report each year, credit scores are not included in that free report; ensure you have both.

When you pull your credit report, look at it carefully for errors. Credit reports include a lot of data on your credit history, reported by banks and landlords, and can contain mistakes. Ensure that addresses are correct, that the accounts listed are owned by you (or were yours in the past), and that any late payments were, indeed, paid late.

Each credit bureau has a specific process to fix any errors on your credit report, so if you find an error, take notes of exactly what you’ve done to work with the reporting agency to fix the error. Unfortunately, consumers (and not the agencies) bear the burden of putting in the work to fix mistakes. Follow up until you are absolutely certain that the error has been fixed.

Evaluate what you can improve. Let’s get back to improving your score. Your FICO score is based on five primary factors, which have different weightings:

  • Types of credit in use (your credit mix): 10% of your score

  • New credit: 10%

  • Length of your credit history: 15%

  • Amounts owed (your credit utilization): 30%

  • Payment history (how you’ve handled your credit): 35%

The type of credit in use refers to the diversity of your credit sources. Do you have five credit cards, but no other loans? This tends to lower scores. Or, do you have a student loan, one credit card, and mortgage? This mix may raise your score, as it demonstrates using credit for different things, with different loan structures, versus a reliance on one type of credit.

This is a smaller portion of your score, so I do not recommend taking out more loans to improve your mix. You should limit your loans to what you truly need. However, if you have many types of the same credit (for example, many credit cards but no other loans) you may want to consider closing some cards. That said, any credit mix improvement will only have a modest impact on your score.

New credit looks at the recency of your accounts. In general, if you don’t have much new credit, your score will be higher compared to someone who has recently opened up several new accounts. New accounts may signal that you are over-extending yourself or aren’t able to pay your debts, which can lower your score. You can’t take proactive steps to improve this element, but you can stop opening accounts to improve this portion of your credit score.

Length of credit history is similarly something you have little control over. Generally, the best credit is old credit, and the factors in this category include how long your accounts have been open, how long since accounts have been used, and how long specific account types (like credit cards) have been open.

Like the new credit factor, there is little you can do to improve this element, though you can take steps to keep older credit, as long as it isn’t too costly to do so. For example, you can pay off a high-interest credit card that you opened in college, stop actively using it, but keep it open to improve your length of credit history over time. Note that this may only make sense if the card doesn’t include any other fees or costs.

If you’re new to credit, and don’t have credit cards or other loans, you may want to open one card and charge a single item on it monthly to start establishing your credit. Once a week, you can pay for your groceries on the card and immediately pay it off. I’ve struggled with credit card debt, so I understand why many avoid credit cards - but if you don’t have a credit history, it can be challenging for lenders to score your creditworthiness, and therefore you’ll end up with higher rates on things like auto and home loans in the future.

Amounts owed, or credit utilization looks at how much you owe (your balance) relative to how much credit you have available. This is a large factor of your score (up to 30%) and - good news - one that you can take proactive steps to improve.

Here, you can have a measurable impact on your score in a relatively short period of time. For example, if you lower how much you owe on “riskier” accounts like credit cards, your score will increase. FICO does not treat all debt the same, and mortgage, auto, and student loans don’t hurt your score in the same way that credit card debt does.

This is because credit cards have a balance that you control - your choices each month determine how much credit you’ll use, and therefore how large your monthly bill will be. In contrast, an auto loan has a fixed structure. Your auto loan was provided out for a certain amount, and you paying on a set schedule each month. This is a less risky proposition for lenders, who like predictability.

If you have credit cards with a balance, my recommendation to improve your credit utilization is to take out all of your credit cards, write down the balances you owe and the interest rate, and start paying off the highest interest rate cards first. This will save you money by lowering the interest you pay and eventually improve your credit score.

Similarly, you can call each credit card and request a higher credit limit. An increased limit means that you will be using less of your available balance. However, it is important that you aren’t tempted to use your credit cards more to take advantage of your higher limit.

If you keep your credit cards open when you pay them off, this can help your score (because you are using less of the total credit available to you). Again, this can be a balancing act with the first factor (type of credit in use) - but remember, that is a much smaller portion of your score, at only 10%.

If you don’t have credit card debt, but have other debt (like student loans or auto loans), you can also work to reduce those balances. The amount of debt you have left on these loans is also a contributing factor to your credit utilization, and paying off your loans faster than expected can also help your credit score.

Some auto, student, and home loans make it a little tricky to pay down your loan balance earlier. I recommend calling your lender to understand the preferred way to make extra payments, so they don’t accidentally apply it to your next month’s payment - which would help you next month, but would not lower your balance faster. Tell the lender you are interested in making an extra payment towards the principal balance of the loan, and then keep an eye on your next statement to ensure it was applied correctly.

Payment history is the largest single factor in your credit score, at 35%. This element looks at how you’ve handled the credit you’ve been provided in the past, which FICO has found is a good predictor of future behavior.

Payment history includes seven sub-components, including length of overdue accounts, amount of money in collections, and past due items. Negative items like bankruptcy or an unpaid account that went to collections can stay on your credit report for 7 - 10 years. Since this section includes historical information, there are limits to the proactive steps you can take to improve this section of your credit score.

That said, you can take steps tomorrow that will improve your score in the future - these include prioritizing getting up-to-date on any accounts that you are behind on and checking your report for errors as I mentioned above.

Managing your credit in the future. In addition to the steps above, you can take active steps to protect and manage your credit to it continues to improve in the future. Two of the most powerful steps you can take are only accessing credit when you critically need it and paying your balance on time.

If you only access credit when you critically need it, you are less likely to be tempted to fall into debt and will have a cleaner, tidier credit report. Women are often tempted by store cards that are offered by retailers when we’re shopping - I urge you to avoid these, as they are some of the highest interest-rate cards on the market, and also increase the number of credit cards you need to manage. Twenty percent off your purchase isn’t worth increased debt and stress.

Additionally, if you pay your balance on time, consistently, you are taking one of the best steps you can to improve your score. If you’re going to have trouble paying a bill, call your lender and work out an arrangement - many will accept a partial payment. Your lender reports missed payments to the credit bureaus, so you’ll want to work proactively with lenders to ensure they know your payment is coming, and don’t report a missed payment instead.

Finally, you may want to consider freezing your credit. This is a simple, effective, step you can take for a modest fee (often $5 or $10, and in some states, it is free). If you freeze your credit, no one can open up any credit without your confirmation first. This is a powerful step to protect yourself from fraud, which can have devastating effects on your credit report and score.

You can freeze your credit by contacting the three agencies directly. The last time I froze my credit I was able to complete the entire process for each agency online, in under thirty minutes. When you freeze your credit, you are given a PIN that you will unlock your credit should you need to apply for a loan in the future. Save this PIN in a safe place, and should you need a loan in the coming years, you simply contact the agencies and provide the PIN so the lender can pull your credit.

Candidly, I recommend a credit freeze over credit monitoring, because a freeze is more preventative. Credit monitoring tells you if something looks incorrect, which means you may have already been a victim of fraud. Additionally, credit monitoring often involves expensive, monthly fees.

I wish you the very best as you work to strengthen your credit! If you take steps now, you can move your credit score up, putting you in a more favorable position for your next loan, saving you a tremendous amount of money in the long run.

xoxo,
Ms. Financier

How Many Credit Cards Should You Have?

Credit can be a beautiful thing – allowing you to safely make purchases and earn rewards. Managing credit cards responsibly can help your credit, which can make you a more attractive renter, get you a better interest rate, and can even impact your candidacy for a new job.

However, paying with credit cards disassociates us from the physical act of spending cash, making it easier to spend more money. Further, there’s a reason that card companies offer bonuses and points. The average American household has a credit card balance of $8,377 and has an interest rate that is greater than 12%.

While credit can be powerful, it can also be a nightmare; I’ve struggled out of credit card debt many times. I’m now out of credit card debt and have vowed to never rack up a balance again. One key to reining in my debt was properly managing the right number of credit cards. So, how many credit cards should you have? My answer is at least two, and no more than four.

Why do you need to have at least two cards? You may run into a situation where your card isn’t taken by a particular merchant. Select at least two cards and ensure at least one is a Visa or MasterCard; these are widely accepted. Discover and American Express can offer powerful benefits but tend to be accepted by fewer stores.

Why shouldn’t you have more than four cards? Because complexity makes it more difficult to manage your debts. Psychologically, it can be “easier” to spend if you have more cards – your Visa may have a $2,300 balance, but your Discover is paid off; so charging that new maxi dress to your Discover isn’t that bad…(Yes, it is!)

Beyond your two basic credit cards, add up to two more that allow for special benefits. For example, one of these might be a card tied to a hotel chain or airline that you frequent and provide additional value like upgrades or early boarding. One might be a card linked to a charity you support; this allows you to donate regularly to a cause via your regular spending.

What shouldn’t you do?

No store cards. I’m serious; store cards offered by retailers have very high interest rates and generate huge profits for the businesses that offer them. There’s a reason why every cashier asks if you’d like to save today by signing up – many are compensated to do so because of the revenue these cards generate.

Avoid cards with annual fees. There’s no reason to pay an annual fee for a card unless you’re absolutely certain it is a good value. One of my frequent traveling friends has an airline-branded credit card, with an annual fee of nearly $500. However, because she’s constantly on the road, the cost of the lounge access provided by this card is worth the high annual fee. She can grab free snacks, drinks, and a quiet place to recharge between flights; some lounges even have showers for post-red-eye refreshing.

No foreign transaction fees. If you travel, secure at least one card that doesn’t have a foreign transaction fee. Foreign transaction fees hover around 3% and are charged when you buy an item in a foreign currency. That can add up for frequent travelers.

Don’t add your partner to your card too early. Credit card debt accumulated on a joint card is the responsibility of both parties. If your partner racks up a $25,000 credit card bill on a joint account, you share liability for that debt. I would not add someone to my credit card account unless I had a legal agreement in place that dictated payment responsibilities in situations like this; (a cohabitation agreement or prenuptial agreement can cover this.)

Don’t churn cards for points (unless you have the time and are extremely disciplined). There are many stories about people who funded luxury vacations using the “free” points they got from “churning” credit cards (signing up for cards temporarily to take advantage of card bonuses.) Most of us don’t have the time and focus to keep track of the details needed to profit from this exercise.

If you have too many cards, start canceling them gradually. Your credit score may take a small dip, but it is worth it to avoid managing many cards. You could also cut up your cards and wait to close the actual account (unless there is a fee associated with the card, in which case I’d suggest canceling it right away.)

Sort your cards by interest rate and credit limit; keep those you've had the longest, with the lowest rates and highest credit limits. You may also elect to negotiate those before you cancel, if there’s a card you love to use but it has a very high interest rate, for example.

Don’t ring up a balance you can’t pay off. Get into the habit of paying your credit card debt off every month. As someone who has struggled with credit card debt, I have to put steps in place to ensure I don’t overspend. I only put expenses greater than $100 on credit cards, and I transfer the money immediately from my checking account to my credit card – typically the day I make the purchase.

Get your finances in order by getting the right number of credit cards in your wallet! There are many resources for you to compare credit cards and select the right one for you, including NerdwalletCredit Card Tune-Up, WalletHub, and Consumer Reports.

What are your credit card tips? Is there anything I missed? Let me know your thoughts - you’ve got this!

xoxo, Ms. Financier

This post also appeared on the Fairygodboss blog - I love their mission to improve the lives and workplace for women, through transparency.

My Money Mistakes: The Four Times I Accumulated Credit Card Debt

I’ve made a commitment to share my money-related mistakes. These financial lowlights aren’t my proudest moments, but I hope sharing my missteps can help remove some shame and embarrassment from the topic of personal finance.

My mistake with credit cards is a series of mistakes that repeated it four times. Unfortunately, I’m not alone in accumulating too much credit card debt. As of this writing, the average American household has a credit card balance of $8,377 and has an interest rate that is greater than 12%. Consumers typically have 9 credit cards and approximately 14% of Americans have more than 10 cards. (This is far more than the number of credit cards I recommend, which I’ll cover in the next post.)

Mistake #1: Credit card debt in college. I was thrilled when I got accepted into the University of Michigan, the only school I wanted to attend. (Go Blue!) When school started, I couldn’t believe how lucky I was to be attending a school in beautiful Ann Arbor, with fascinating classes, inspiring campus life, and creative, thoughtful students.

It was also my first exposure to those who appeared very wealthy. Some students had cars that cost more than my childhood home, parents that bought them an Ann Arbor house as “an investment property,” or spent their winter break in Switzerland. My sturdy Eddie Bauer backpack seemed out of place - many of the women in my classes carried their books in Kate Spade, Fendi, and Louis Vuitton bags, which I had only seen on Sex and the City.

By the time I reached my junior year, I had accumulated around $2,500 of credit card debt. This debt wasn’t for my books or school supplies, but all splurges I felt I had “earned.” You know, because I was working so hard in school...and “all” my peers had nice stuff, too, so...

To manage the credit card debt, I ignored it and headed off to my summer internship in Washington, D.C. One evening, I was walking to the Metro when my cell phone rang. It was the credit card company, frustrated by my lack of payment. The representative offered to “charge off” my debt. I happily accepted.

Once I returned to campus to begin my senior year, I checked my credit score. It was in the toilet because of my decision to ignore my debt. I worked out an arrangement to repay the debt, which modestly improved my score. My first experience with credit card debt was a double-whammy; I accumulated debt buying things I didn’t need and did a horrible job of managing the debt. I swore I’d never get into credit card debt again.

Mistake #2: Credit card debt after moving to D.C. After I graduated, I moved to the nation’s capital and promptly racked up another credit card bill, around $2,700. I thoughtlessly swiped my credit card to buy essentials for my first solo apartment, shop for a work-appropriate wardrobe, and splurge in D.C. bars and restaurants.

Further, if I had been shocked by the wealth I saw on display in Ann Arbor, D.C. was another level. I vividly remember going to “pregame” one evening at a colleague’s apartment, which had amazing views of the National Mall. He told me it was his parent’s second home, which he’d be getting when his trust fund kicked in. This started a conversation on provisions in trust funds; I finally understood how my peers could afford their lifestyle. Unlike me, they had another meaningful source of income beyond their entry-level job.

About six months into my new job, I got my act together, stopped spending thoughtlessly, and actively sought out friends that didn’t live a lavish lifestyle. I also earned a promotion (and pay increase); all of my extra income went towards my credit card debt. I promised myself I’d never get into credit card debt again.

Mistake #3: Credit card debt after buying a home. I’ve shared the massive size and wild terms of my first mortgage. When my partner and I moved in, we left a 500-square-foot studio apartment for a 3,000+ square-foot house.

There were plenty of things we needed (fire extinguisher, household tools, window coverings for our bedroom) and plenty of things we convinced ourselves we needed (brand new furniture). Together, we racked up over $12,000 in credit card debt. This was the largest amount yet; a massive mortgage and large credit card balance made me feel trapped.

In 2006, Mr. Financier and I created a goal to eliminate our credit card debt in one year, with two $500 payments each month, diverting any “found” money to debt, and reducing three household expenses. We paid the debt off earlier than planned; I kept a handwritten log next to my bed to track our progress.

This was the most significant credit card debt I’d ever paid off, and I swore I’d never get into credit card debt again.

Mistake #4: Credit card debt following a significant raise. When I started my consulting career, I set a goal to be a Director by the time I turned 30. Colleagues in this position were generally 35 or older, but my career ambition and desire to grow my income inspired me to put my nose to the grindstone and shoot for this lofty goal. I earned a promotion into the Director position the month after I turned 30; my base salary rose to $150,000.

In End Financial Stress Now, Emily Guy Birken writes about the windfall effect. When we receive a windfall - an unanticipated bonus, or a generous birthday check - we’re more tempted to frivolously, quickly spend it. Our brains tend to compartmentalize and we view the extra money as distinct from our paycheck (which we spend more responsibly). One study on the psychology of unexpected, windfall gains concluded, “...the unanticipated nature of windfall gains is responsible for their heightened proclivity to be spent.”

I had one hell of a windfall on my hands, so I did what all responsible adults do in that situation. I rewarded myself well before I had actually saved the money to do so. Yup, you guessed it - I racked up another $3,100 in credit card debt. After the high from my shopping sprees wore off, I felt sick to my stomach. How in the world did I end up in debt, again?

It was this fourth time in debt that forced me to break my pattern. I was ashamed to be carrying a balance on my credit cards (yet again) and my debt dulled the achievement associated with my promotion. I had more than enough in my emergency fund to pay the debt off, but refused to do so, forcing myself to pay the costly interest charges as penance.

My fourth time in debt finally caused me to reflect on what habits I needed to change; there were four.

1. Watch out for life changes. I realized that I’m vulnerable to credit card debt during big life changes or times of stress. I’d feel like I “deserve” something nice and this emotional spending would push me into debt. This may not be unique to me, but since I’m conscious of this fact, I put my credit cards on lockdown when change is afoot and watch my spending even more closely.

2. Increase my save-to-spend account. I needed a cushion to fund the things I enjoy. My budget was so lean that I didn’t leave myself enough space for occasional splurges. I adjusted my automatic savings, increasing the amount going to my “save-to-spend” accounts to allow for the things I love, like shoes and dining out, that can tempt me into debt.

3. Change my shopping habits. I adjusted my shopping patterns to make myself less vulnerable to temptations. I stopped meeting up with girlfriends to shop - instead, we went to art galleries, parks, vineyards. I stopped browsing and only go shopping (online or in a store) when I have a specific item missing from my wardrobe. And, I unsubscribed from the many email lists I was on from my favorite retailers. If I missed out on a huge sale, so be it - I wouldn’t miss the possibility of subsequent debt.

4. Stop using credit cards by default. I changed my default card to my debit card, which pulled directly out of my checking account. Today, I only “allow” myself to put expenses greater than $100 on credit cards and I transfer the payment immediately from my checking to my credit card, so I can’t be surprised by large credit card bills.

I currently remain out of credit card debt and love getting zero-balance credit card bills in the mail. My money mistake with credit cards is one that I chose to repeat until I took the time to address the underlying issues. Have you struggled with credit card debt? Or, are you one of the lucky ones that excel at keeping your cards under control?

xoxo, Ms. Financier