A FICO score is akin to a GPA for your personal finances. People who have great credit scores can borrow at lower rates, get insurance at lower prices, and save as much as $68,000 in interest on a $200,000 fixed rate mortgage compared to those with lower scores.
Knowing how to get and keep a great credit score is perhaps one of the most important things you'll never learn in school. Here are the three best tips for maximizing your score.
1. A low-effort method for improving your score
After managing his borrowings responsibly for the better part of two years, a friend checked his score only to see that it was much lower than he anticipated. His score, which he thought would be close to prime, if not better, was situated just above subprime territory.
He was doing almost everything right. In an effort to improve his score, he opened a $500 secured credit card, used it responsibly, and paid it in full every single month for nearly two years. But the card that was designed to improve his score was actually hurting his score.
Because his limit was small ($500), his monthly purchases of approximately $450 put his utilization ratio at 90% every single month. (Credit utilization is the amount you owe divided by the credit line.)
According to MyFICO, utilization makes up as much as 30% of your score. Experts suggest that an ideal level of credit utilization is 30% or less on each account and across all accounts. Thus, a credit card with a credit line of $10,000 should have a balance of no more than $3,000 at any given time.
There are two quick and easy ways to improve your score here:
- Pay off your credit cards at any point you top 30% in utilization, even if it means making more than one payment each month.
- Ask your credit card company for a credit limit increase. By increasing your credit limit, but not your spending, your credit utilization will decrease. For example: A $2,500 balance on a $5,000 credit line would result in a problematic utilization ratio of 50%. The same balance on a $10,000 card would amount to 25%, a safe level of utilization.
Utilization is frequently reported in the middle of a billing cycle, so paying in full when the bill comes due won't necessarily result in a 0% utilization ratio. As for my friend, he paid his card in full before the due date, stopped using it for a month, and saw an 80-point increase in his score when his report updated to reflect his new $0 balance.
2. Managing monthly payments
The single worst thing you can do is pay your bills more than 30 days after they're due. FICO data from Equifax suggests that a single 30-day late on an otherwise perfect record could result in a decline of 90 to 110 points. Even those with a so-so score of 680 could see their score plummet 60 to 80 points from a new 30-day delinquency.
There are a few ways to manage your monthly payments so that you don't run into trouble:
- Ask for a different payment date. I like to have all my bills come due at the same time, so that I can take care of them all at one time each month. Most service providers and creditors are willing to move due dates for people who are current on their accounts.
- Transfer an unpaid balance. If you're suffering from a short-term cash crunch, a quick balance transfer can help you extend the payment on an upcoming bill. By transferring an amount equal to the minimum monthly payment from one card to another, you'll avoid a late payment. Similarly, mortgages and other installment loans can be paid by credit card, although one should expect to pay a 3% convenience fee for using a card to make the payment.
Learn more about strategies for avoiding late payments and how to get old late payments removed from your credit report.
3. Keep old accounts open
Older credit accounts help extend the life of your credit record, which can make up 15% of your credit score. The important factors here are the age of your oldest account, as well as the average age of all accounts.
Generally speaking, creditors close accounts that haven't been used in more than one year. Thus, you'll need to use accounts minimally to keep them alive.
Not all accounts are worth keeping open. If your oldest card account has an annual fee, and you don't want to keep using the card, cancel it and focus on keeping your second-oldest account open. Otherwise, your oldest card is worth using once or twice a year to buy a tank of gas or a week's worth of groceries. Pay it in full and sock drawer it for a few months before repeating the process.
Given how many recurring payments many people have to make (cable, phones, online media streaming, etc.), you can probably keep a handful of old accounts open by using each one to pay one recurring bill. Save time by setting up automatic payments to pay the credit card bill in full each month.
Those who know the ins and outs of credit scoring algorithms can use them to their advantage to get a great credit score and all the benefits that come with it. Getting a great credit score is really as simple as keeping your credit utilization below 30%, paying your bills on time, and keeping your old accounts active so they'll keep reporting every single month.