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Improving Your Credit Score

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Many people suffered blows to their credit scores during the unstable economy of the last few years, whether because they missed payments, exceeded credit limits or, more seriously, experienced a home foreclosure or even bankruptcy. Is this a big deal? Absolutely.

If your credit score drops significantly, you'll likely be charged higher loan and credit card interest rates and offered lower credit limits -- or perhaps be disqualified altogether. And, lower scores can also lead to higher insurance rates and harm your ability to rent an apartment or even get a cell phone.

Fortunately, there are a few steps you can take that will begin improving your credit score almost immediately:

Establish a baseline. First, review your credit reports from each of the three major credit bureaus (Equifax, Experian and TransUnion) to find out what negative actions your creditors have reported. While you're at it, look for any errors or possible fraudulent activity on your accounts. You can order one free report per year from each bureau through the government-authorized AnnualCreditReport.com; otherwise you'll pay a small fee.

You can also order a FICO® credit score (the score most commonly used by lenders) for $19.95 from MyFICO.com to know exactly where you stand. Generally, FICO scores over 740 are considered excellent, while those falling below 620 may make it tough to even qualify for a loan.

"It definitely pays to have a good FICO Score," says Greg Pelling, vice president of Scoring and Analytics at FICO, the leading developer of credit scores. "Based on today's rates, a good score could save you almost $6,000 in interest payments on a three-year, $25,000 car loan. Or save you $30,000 on a $100,000 home loan over 30 years, if your score is above 740 rather than below 620. Lenders base their decision on many factors but your FICO score plays a major role."

Banish late payments. A single late mortgage payment could knock 100 points off your score, so set up automatic payments for recurring bills (mortgage, utilities, etc.). Also consider setting up automatic minimum credit card payments if you're prone to forgetting or travel a lot. And sign up for text or email alerts from your bank or credit union for when your balance drops below a minimum amount.

Monitor 'utilization.' Exceeding individual credit limits is another good way to get dinged. In fact, the lower your credit utilization ratio (the percentage of available credit you're using), the better. Try to keep your overall utilization ratio -- and the ratios on individual cards or lines of credit -- below 30 percent. Although it usually it makes sense to pay down credit accounts with higher interest rates first, if you've tapped more than 30 percent of available credit on a particular card, bringing that percentage down first may help boost your score more quickly.

Timing is critical. Even if you pay off your balance each month, showing a high utilization ratio at any time during the month could conceivably hurt your score if the statement balance is elevated when it gets reported to the credit bureaus. This is especially problematic for people whose credit limits were lowered after the recession began. A few suggestions:
  • Spread purchases among multiple cards to keep individual balances lower -- while still paying off as much as you can each month, of course.
  • Make an extra payment midway through the billing cycle so your reported outstanding balance appears lower.
  • Ask lenders to reinstate higher limits if your payment history has been solid -- but don't tap the extra credit just because it's there.

Be cautious with transfers. Transferring balances to a new credit card account to get a lower rate will ding your credit score by a few points -- although it won't take that long to recover. But, say you move a $2,000 balance from a card with a $10,000 limit to one with a $4,000 limit; you've immediately gone from a 20 percent utilization ratio to 50 percent on the new card. Plus, if you then close the higher-rate card, you'll only compound the problem by both lowering your available credit and erasing a longer-term account from your credit history.

Mix it up. People who demonstrate managing several types of credit earn higher scores, so if your revolving (credit card) payments are under control and you don't have any outstanding installment loans (mortgage, car, student), consider taking out a small personal loan and paying it off on schedule. Just make sure the lender will report it to all three bureaus.

A few other credit score-improvement tips:
  • Make sure that credit limits on individual cards reported to credit bureaus are accurate.
  • Don't automatically close older, unused accounts; 15 percent of your score is based on credit history. In fact, make occasional small charges on existing accounts (paying them off, of course) to make sure the lender doesn't close them out.
  • Each time you open a new account there's a slight impact on your score, so avoid doing so in the months before a major purchase like a home or car.
  • Pay off medical bills, as well as parking, traffic or library fines. Once old, unpaid bills go into collections, they can cause major damage to your credit.

There are many good resources for learning more about what you can do to repair and protect your credit scores, including MyFICO.com's Credit Education Center, the FTC's Credit & Loans page, and What's My Score, a financial literacy program run by my employer, Visa Inc., which also features a free FICO® Score Estimator that can help you approximate your score. And check out my previous blog, Understanding Credit Scores.

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.