Consumers can easily boost their credit scores by avoiding some of the fallacies surrounding the extremely convoluted manner in which credit scores are tabulated.
Each of the three credit bureaus uses its own formula and guards its methods closely, but consumers shouldn’t find themselves in a conundrum when they are examining their strategies on paying off credit cards and other bills.
Consumers reap many rewards when they raise their current credit score, because higher scores mean shelling out less money in interest, which can yield thousands of dollars in savings. A high credit score also means consumers receive a lower interest rate for credit cards, auto loans and mortgages, and the benefit extends to lower rates for auto and home insurance premiums.
For a quick gauge of where you stand, here’s a quick rundown: a score of anything below 620 ranks as poor, 620-699 is fair, 700-749 is good and anything over 750 is excellent.
Check out your credit reports from Equifax, Experian and TransUnion at least once a year and examine them for errors. Consumers can access credit reports annually for free at www.annualcreditreport.com.
Paying Your Bills Is 35 percent of a Credit Score …
“If there are any inaccuracies, from an address to an incorrect outstanding balance on a credit card, correct them right away by following the directions on each agency’s website,” said Kevin Gallegos, vice president of the Phoenix operations for Freedom Financial Network, a consumer debt resolution company. “Under the terms of the Fair Credit Reporting Act, the credit bureaus must investigate any disputed items and remove them from the credit report if they cannot be verified.”
Even though you might be pinching pennies and waiting for each paycheck anxiously, make sure your top priority is to pay every single bill on time, every time. Lenders look for borrowers who pay their bills on time. A consumer’s payment history accounts for 35 percent of your credit score, “making it the largest piece of the pie,” said Bruce McClary, spokesman for the National Foundation for Credit Counseling, a Washington, D.C.-based non-profit organization.
“Making timely creditor payments should top the list of healthy habits that help build a better credit score,” he said.
Keep your credit card balances low and minimize the percentage utilization to under 35 percent, said Gallegos. For an individual with a credit card with a limit of $10,000, a balance of $3,500 is already a 35 percent utilization ratio.
“Anything over 35 percent is considered high and can impact credit scores,” he said. “Over 50 percent will have a definite negative impact on a credit score and a maxed-out card will very negatively impact the score.”
Pay off the balance of secondary credit cards that you rarely use, because those balances “just muddy up” your credit report, said Howard Dvorkin, a certified financial planner and chairman of Debt.com, a Plantation, Florida-based financial advice website. Keep your report clean, so limit it to one or two cards.
“Building up a credit score is time consuming, so take baby steps,” he said. “Pay your bills on time. Don’t mess with this step or you’ll fall flat on your face. Your mantra should be: pay on time, pay on time.”
Store Credit Cards Aren’t a Good Option …
Avoid signing up for credit cards offered by retailers. The discounts they offer are tantalizing, but the interest rates they offer are very high, even up to 27 percent. Even worse, some retail credit cards come with an interest rate that is the same for every customer, treating those with exceptional credit scores exactly the same as those who are below average, McClary said.
Sears offers three cards — both the Sears and Sears MasterCard cards offer a whopping APR of 25.24 percent, and the store’s “Home Improvement” account offers 14.40 or 18.40 percent based on creditworthiness.
“It doesn’t appear that lower rates are available for those with excellent credit,” he said.
Offers from your local furniture store to consumers to finance a purchase can often come from a subprime lender, even if your credit score is good. These retailers are simply using subprime lenders or companies that finance loans for consumers with lower credit scores.
Reading the fine print will help you avoid having a subprime lender on your credit report. While doing business with a known subprime lender may not have any impact on your score, it may end up being another item you need to explain when a company like a mortgage lender takes a look at your credit history, McClary said.
If you regret opening a store credit card or find that you rarely shop there, don’t automatically close it. Opening and closing accounts too frequently should be avoided.
“Keeping a credit card for a long period of time helps build a lengthy credit record which ultimately benefits the score,” he said.
Credit Cards Build Your Profile …
Not using credit cards at all is not the solution either, said Gallegos. The credit bureaus can only “rely on past payment history to help determine how borrowers will do in the future,” he said. If you refrain from borrowing and only use your debit card, then potential lenders have no information to base their expectations.
Build your credit report by taking out one credit card such as one with a low limit and pay off the balance each month, said Josh Tschirigi, a financial adviser at Somerset Wealth Strategies in Portland, Oregon.
“Once you get comfortable with this card, it’s a good idea to take out additional cards, because one factor in calculating a credit score is how many credit card accounts you have and how long you have had them,” he said. “The more you have and the longer you have them, the better your credit score is if you avoid debt delinquencies.”
Medical debt is now being treated differently and the changes in credit scoring means the debt will not be weighed “as heavily as credit card or other kinds of debt,” Gallegos said.
“Building a strong credit score comes from people being aware of their overall financial picture and they must learn and understand loans, debt, credit cards, income, cash flow and savings,” said Shawn Gilfedder, CEO of McGraw-Hill Federal Credit Union in East Windsor, New Jersey. “With a better understanding of their personal finances and by setting goals, they will then be able to change habits.”