How are credit scores are calculated?

Your credit score is calculated by a company that applies a credit scoring model to the information in your credit report. For example, your FICOⓇ Score is calculated by the Fair Isaac Corporation using a secret formula developed by the company itself. The information that plugs into this formula comes from the credit report on file at one of the three credit bureaus (Equifax, Experian, and TransUnion).

How do you increase your credit score?

The biggest thing you can do to increase your credit score is to always make your payments on time. After that, the second-biggest thing you can do is to keep your credit utilization ratio low. A few smaller things can also help, such as only applying for new debt when you need it, keeping your old credit cards open to establish a long credit history, and keeping a mix of different types of accounts.

How to Increase Your Credit Score

Q: How long does it take to rebuild your credit?

You can think of rebuilding your credit score as a two-phase process. In the short term, you can do things like pay down your debt (especially credit card debt), ask to be an authorized user on a trusted (and responsible) friend or family member's account, and ask for a credit limit increase on your existing credit cards. However, long-term changes can take several years to show up in your credit score, and these can have the biggest impacts. If you have late payments or other negative remarks on your credit report, it can be a full seven years before they're erased, although their effect on your credit score will lessen over time. In the meantime, making all your payments on time and keeping your debt low will help you rebuild your credit over several years.

Your credit score is key to so many areas of your financial life. A good credit score means you're more likely to get approved for the best credit cards and loans, and you won't have to pay an arm and a leg for them.

Even if you don't plan on taking out any loans or credit lines, it has wider-ranging effects too. For example, you may need a certain credit score in order to rent an apartment. If your credit score isn't top-notch, you may also be required to put deposits down on utility accounts, or even be denied for certain jobs.

Luckily, increasing your credit score isn't too difficult, even if you've run into problems in the past. You just need a basic understanding of how credit scores work, the discipline to follow through with a few good financial habits, and a little bit of time.

How credit scores are calculated

If you take out a loan or owe money to a company, chances are that they've reported that information to one or more of the three credit bureaus: Equifax, Experian, and TransUnion. These credit bureaus keep information on file about your payment habits, such as how much you owe, what kind of account it is, and whether you've made your payments on time. This information is included in your credit report.

Your credit report can then be used by other companies such as FICO (the most popular credit scoring company) to calculate a credit score. Thus, your credit report is a bit like your teacher's grade book from your elementary school days, and your credit score is a bit like your final grade.

Some parts of your credit report are more important than others when calculating your credit score, and different models work in different ways. To give you an idea of how it works, here are the different factors that make up your FICO® Score:

Payment history: 35%
Amounts owed: 30%
Length of credit history: 15%
Credit mix: 10%
New credit: 10%

How to increase your credit score

As you can see above, some factors affect your credit score more than others. Some factors also take more time to fix than others, which is useful to know when planning out how to increase your credit score.

For example, if you're looking to apply for a new credit card next month, you'll want to focus on the things you can do to improve your credit score within a short time frame.

Check your credit report and dispute inaccuracies

You'd think that your credit report would be accurate given how important it is. Surprisingly, it's actually pretty common to find errors on your credit report, and these can negatively affect your credit score.

You can check your credit report for free once per year with each of the three credit bureaus at the official government website, AnnualCreditReport.com. Go through your credit report with a fine-toothed comb and make sure everything on it makes sense. If you spot something fishy, you can dispute it with the credit bureau. Once it's fixed, you may see an immediate change in your score.

Pay bills on time including utilities and cell phone payments

Did you notice that the biggest factor affecting your credit score is payment history? By paying your bills on time you can avoid late charges being reported to the credit bureaus. If you have trouble remembering, you can set up reminders for yourself, or even put your accounts on autopay.

Even one late payment can lower your credit score, and it stays on your credit report for a full seven years (although thankfully its negative impact will fade over time). Once you have a late payment on your credit report there's not much you can do besides wait for it to go away. That's why paying your bills on time is the single most important thing you can do to improve your credit score.

Reduce debt

The amount of debt you owe is the second-biggest factor affecting your credit score, specifically how much credit card debt you owe relative to your credit limit. This is known as your credit utilization ratio.

You can increase your credit score by keeping this number low, ideally as close to zero as possible. In fact, the best advice of all is to pay off your credit card in full each month if you can. That way, you'll also avoid having to pay any interest. That can be a big ask, though, especially if you're like millions of other Americans who carry a balance on their credit cards from month to month.

Thankfully, even if you can't pay off your bill entirely, there are still some moves you can make. Here are some proven strategies you can still use to keep help boost this aspect of your credit score:

Ask your credit card issuer to increase your credit limit: As long as you don't spend your new increased line of credit, your credit utilization ratio will go down even though you're still carrying the same balance.
Make multiple payments throughout the month: Nothing says you have to make just one payment a month. Paying off your balance throughout the month -- as many times as you want, in fact -- can keep it at a more manageable level.
Keep your credit utilization level below 30%: Zero is better. But if you can't manage that right now, 30% or less is a good target to aim for in the meantime, according to many financial experts.

Apply for new credit sparingly

When you apply for new credit such as a credit card or a loan, it'll be recorded on your credit report as a hard credit inquiry regardless of whether you're approved or not. These credit inquiries don't last as long (just two years, although they'll only be factored into your score for 12 months), but they can lower your credit score.

Credit inquiries typically don't decrease your credit score by a lot, but if you don't have much information on your credit report already, that dip could be larger. That's why it's best to wait to apply for credit until you think you're likely to be approved. If you are in the market for a loan, don't let this stop you from shopping around for the best rates. In some cases, such as if you're shopping for an auto loan, all of your loan applications will be treated as a single inquiry if you complete your rate shopping within a 14- to 45-day period.

Consider a secured credit card

If your credit is poor or you don't yet have a strong credit history, getting approved for new credit can feel like a chicken-and-egg situation. You need to have a credit card or loan in order to build your credit, but you also often need a good credit score in order to be approved for said loans and credit cards.

An easier solution might be to apply for a secured credit card. Secured credit cards require an upfront deposit that's usually equal to your credit line on the card. That upfront deposit means that these cards are often available with much looser credit requirements because it minimizes the risk to the lender. They're also often more expensive and carry less rewards than a typical credit card, so it's a good idea to trade up to a standard credit card once you're able. Call your credit card company and see if you can switch up to a better credit card rather than closing it outright. That way, you can keep your current credit line open, which will help increase the length of your credit.

Talk to your collectors

Late payments and delinquencies on your account are serious setbacks that are hard to overcome. If you're in these shoes, it's worth reaching out to your collectors to see if you can work out a payment plan to keep a negative remark off your credit report.

The laws around debt collection can get a little wonky. If you're overwhelmed, one good option is to seek out help from a reputable credit counselor with the National Foundation for Credit Counseling.

Maintain a mix of credit accounts

Finally, the types of credit you have can also affect your credit score. If you have more than one type of account, such as a personal loan and a credit card or an auto loan and a mortgage, for example, you're showing to potential creditors that you can manage more than one type of debt.

This isn't a huge factor in your credit score, and we never recommend taking on more debt just to build your credit score. But if you just so happen to be looking to finance a necessary purchase, you could consider opening another type of account in order to help increase your credit score.

If you have a trusted friend or family member, one handy trick you can use is to ask to be listed on their credit card account as an authorized user. This gives you the benefit of having their entire account history listed on your credit report as well, just as if you'd been the one with that account the entire time.

Obviously this isn't something to be taken lightly. You'll need to trust your friend or family member to manage the account well so that you don't get hit with any penalties from their mismanagement. They'll also need to trust you in turn if they plan on giving you a secondary credit card to use, which they don't necessarily have to do.

Be patient and diligent

Some aspects of your credit score take time and require your constant attention. For example, if you forget to make a loan payment for a single month and it drops your credit score, there's not much you can do besides wait.

After all, your credit score is designed to show lenders how well you manage money in the long term. Yes, there are some quick fixes that can boost your credit score almost immediately. But when you boil it all down, the best thing you can do is make sure you never miss a payment and manage your debt responsibly.

How do changes affect your credit score?

Sometimes, working to increase your credit score can be a bit of an exercise in frustration because the changes you make might not have the impact you expect. That's because the formula to calculate your credit score takes into account a wide range of factors, which might have different effects depending on your situation.

For example, in general, you can count on increasing your credit score by paying off debt. But in some cases, such as after you pay off an installment loan, you may actually see a decrease in your credit score in the short term.

The best advice is to stick with the general rules listed here because those are most likely to help you regardless of what changes you make going forward.

How long does it take to rebuild your credit score?

Everyone's credit situation is different. The options available to one person might not be there for someone else. But in general, these things can help improve your credit in the short term:

Making all of your payments on time
Correcting any incorrect information on your credit report
Paying down your balances (especially credit card balances)
Keeping old credit cards open to build your credit history (unless you're not using them and they have annual fees)
Being added as an authorized user on a responsible friend or family member's account

If you have any credit inquiries, late payments, delinquencies, bankruptcies, or other negative remarks on your credit report, there's not much you can do to improve these factors in the short term. Most of these items stay on your credit report for a full seven years. Chapter 13 bankruptcies stay on your credit report for seven years as well, although Chapter 7 bankruptcies fall off after 10 years.

The negative impact of these things on your credit score will fade over time before they eventually fall off. But it still may be difficult to qualify for a mortgage, for example, if you have a bankruptcy or foreclosure listed on your credit report at all.

Still, focusing on good financial practices like paying off your credit card balances in full each month will go a long way towards increasing your credit score. With time, the rest of those negative elements will drop off your credit report, and you'll see nice increases in your credit score as they do.

Keep an eye on your credit score and credit report while you're working to build it up. That way, you can keep tabs on your progress and it'll help motivate you as you see the results from your hard work.