Did you make a New Year's resolution to improve your credit score in 2017? If you didn't, maybe you should. Improving your credit score can literally save you tens of thousands of dollars in interest on your next mortgage, and it can make it much easier to qualify for the best auto financing and credit card offers. With that in mind, here's where your credit score comes from, and five ways you could boost yours this year.
First, here's where your credit score comes from
When I use the term "credit score," I'm referring to the FICO score. There are a few other scoring models out there, but the FICO score is the one most commonly used by lenders by far.
With that in mind, the actual formula that is used to calculate the FICO score is a closely guarded secret, but we do know the general composition:
- 35% comes from your payment history. Paying your bills on time every month will maximize this category.
- 30% comes from "amounts owed." In addition to the actual dollar amounts of your debt, this focuses on your outstanding debt relative to your credit limits or original loan balances.
- 15% comes from the length of your credit history and includes things such as the age of your credit accounts, how old your oldest account is, and other time-related factors.
- 10% comes from "new credit." Opening too many credit accounts in a short time period can be a negative factor.
- 10% comes from "credit mix." In other words, a credit history that includes a mortgage, credit card, student loans, and credit lines will look better than a history with just one or two of these, all other factors being equal.
Now that we've seen the formula, here are four things you may be able to do in 2017 to boost your FICO score.
1. Keep your credit utilization low -- but not zero
Most experts suggest that at most, you should use 30% of your available credit limits to avoid damaging your credit score. And lower is even better. In fact, the average person with a FICO score of 800 or greater uses just 4% of their revolving credit and no more than 10% of any single credit line.
However, it may surprise you to know that a zero balance on all of your credit accounts may actually be a negative factor. When I interviewed perfect FICO score achiever David Howe a few years ago, he showed me one credit report with a small credit card balance and an 849 FICO score (one point from perfect). He then paid off this balance, and his score immediately dropped by 25 points to 824.
The bottom line is that lower is better -- to a point. Creditors want to see you use your credit responsibly.
2. Ask for a higher credit limit
Here's one you may not have thought of. Since 30% of your score comes from the amounts you owe, and the percentage of your total credit limit is a major factor, there are two ways to boost your score in this category. You could pay off some of your credit card debt, as I've already discussed. Or, you can ask your credit card issuers to increase your credit limits.
As an example, let's say that you have $2,000 in credit card debt, and your total credit limit is $5,000. This gives you a credit utilization of 40%. However, if your credit limits are increased to say, $8,000, this brings your utilization down to 25%, which can be a big boost to your score. To be clear, it's better to pay down debt, but this can be an added boost.
3. Don't apply for any new credit unless you have to
There are some good reasons to apply for new credit. Buying a home is one example. Another good reason is to consolidate your credit card debt on a 0% APR balance transfer credit card. In both situations, the benefits of applying for the new credit certainly outweigh the short-term ding to your score.
Applying for new credit can hurt you in a couple of ways. In the FICO formula, you'll notice that 10% of your score comes from "new credit," which includes things like credit inquiries and new accounts you open. And another 15% comes from various metrics related to the length of your credit history. In both categories, opening a bunch of new credit cards can bring down your score.
To be fair, the impact of any single credit inquiry is likely to be minimal, and only inquiries made within the last 12 months are considered in your score. So if you can let all of your recent inquiries and accounts age, without adding any new ones, it could add some points to your score.
4. Check for errors on your credit report
As a final tip, it's important to check your credit reports for errors on a regular basis. I use the plural of credit report, as you actually have a different report (and FICO score) from all three of the major credit bureaus -- Equifax, Experian, and TransUnion. It's not uncommon to have slightly different information on all three, resulting in slight variations between your scores.
However, it may surprise you to learn that 21% of credit reports contain errors, according to a report by the Federal Trade Commission. Fortunately, it's completely free to obtain a full copy of your credit reports each year at www.annualcreditreport.com, and the process for disputing incorrect accounts or information is pretty straightforward and can be completed online with each credit bureau.