While I hate to say it, credit scores have become an increasingly central part of our lives. Banks check them. Employers do. Your score dictates whether you can finance a car or house. And even online dating services take them into consideration.
But fear not. If you have a low credit score, it's actually easier than you think to improve it. The key is to know how they're calculated. If you can determine this, then all you have to do is work backward to a solution.
How credit scores are determined
While credit scores have gotten a bad name -- and, in many cases, deservedly so -- they actually serve a positive and important function. That is, they provide information to creditors about whether a person is likely to repay his or her debts.
With this in mind, it should come as no surprise that one's credit score is a function of multiple behaviors weighing on financial responsibility. More specifically, as I highlight in the preceding presentation, the major credit bureaus take five factors into consideration (the weight of each is given in parenthesis):
- Past payment history (35%).
- Amount of money currently owed on all credit accounts (30%).
- Length of credit history (15%).
- Types of credit used -- i.e., revolving vs. installment (10%).
- New credit accounts and inquiries (10%).
Not to belabor the point, but this is an extremely important list. Not only does it tell you specifically how the credit bureaus assess your creditworthiness, but it also discloses the relative importance of each factor.
For instance, let's assume that you're trying to improve your credit. How would you go about doing so? The correct answer is that you'd attack each of these five items in order of their importance. In other words, you'd prioritize.
The most important issue to remedy is late payments. Next is your outstanding debt load, followed by the length of your credit history, and so on. It's only by proceeding in this order that you can tackle the problem in the quickest and most efficient manner.
How to increase a credit score
Now, just to be clear, the point here is not to lecture. It's rather to empower. Make no mistake about it; everybody in this world has problems. And many people only wish their biggest challenge was a low credit score.
As a result, if you're struggling with a disappointing credit score, then keep this in mind: Improving it is an extremely surmountable challenge. By approaching it in a disciplined and systematic manner, you'll be surprised at how quickly you can put a bad score in the rearview mirror.
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