Guest author: Andrew Marquis of Guaranteed Rate.
How can I get a great FICO score?
With borrowing rates at near-historic lows, it’s more important than ever to maintain a good credit report and credit score. Your financial health – not to mention your student loan, auto loan, and consumer home mortgage payments – depend on it!
So given that, what are the best ways to maintain a strong credit standing?
And if you’ve had some bumps in the past, how can you improve your credit score?
First off, it’s important to understand that the credit rating system in the U.S. is based on the borrower’s ability to effectively utilize the credit system. If you use the credit system in the way it is meant to be used, you can reap some significant advantages. Put simply, credit is meant to be used for purchases, and then paid off in a timely fashion.
There are a couple common types of consumer debt:
Revolving debt. This is a standard credit card or store charge account where you are required to make a minimum payment each month, but not required to pay the full balance. In subsequent months, a finance charge is applied to the remaining balance, and a new minimum payment and statement balance are calculated. This is where many consumers fall into a trap: by overspending and underpaying! However, if handled carefully and properly, it’s also the area where the most benefit can be gained. Ideally, you will want to limit your spending to roughly 30% of your credit card limit. As an example, if the card has a $10,000 limit, try to limit your monthly spending on this account to $3,000. (If you find yourself regularly exceeding this percentage, you can request a credit limit increase from the creditor.) In a perfect world, you would then pay off the entire balance at the end of the month, which allows you to avoid paying any interest (finance charge). You may also receive benefits from the credit card company in the form of “points” toward travel, air miles, Amazon, and so on, but you should keep in mind that credit card companies often use these offers to lure less-savvy consumers into overspending, and then reap the finance charge as a reward. What I often recommend is to carry three credit cards (for gas, groceries, and miscellaneous spending). If you can use these three cards effectively and pay them off monthly, you will see your credit score soar as you are properly using the credit system. In addition to standard credit cards, there are also store charge account such as for Home Depot, Target, etc. While these accounts may pay some benefits when shopping at the particular retailer they do not carry as large a positive impact towards your credit score profile.
Installment debt. This refers to debt that is collected monthly over a certain time period. For example, you may have a 36-month auto loan where you pay $400 per month, or a 20-year student loan where you pay $700 per month. A home mortgage also falls into this category. By making the payment each month and avoiding late payments, you will maintain strong credit. Accelerating the payoff of an installment debt carries little to no benefit toward your credit score.
So if you’ve had issues in the past, what’s the best way to improve your credit score? First of all, make sure to take a look at your credit report from time to time. There are a number of consumer monitoring sites that allow you to monitor your credit and obtain a free copy of your report for review every so often. If there are any mistakes, or late payments misreported, you’ll want to contact the creditor directly to have the correction made and updated advice provided to the three credit repositories (Equifax, Experian and Transunion). As stated previously, having three credit cards on which you charge no more than 30% of the limit and pay off monthly is a huge boost.
You should also avoid erratic behavior such as opening a bunch of new accounts at once or having too many credit inquiries in different areas. Attempting to open multiple new accounts at the same time is seen by the credit repositories as risky behavior, as you’ve not yet proven the ability to repay in a timely fashion. Along similar lines, inquiring in a bunch of different areas at once (credit card, car loan, mortgage) is read as risky behavior as well. On the other hand, having three or four mortgage lenders pull your credit score while shopping for your new home loan is simply read as “shopping” and therefore doesn’t carry any negative impact towards your score. Each inquiry is coded as a certain area, such as “mortgage,” “revolving charge,” etc.
Identifying and resolving any past due payments is also a huge boost to credit. Sometimes you may have an old medical bill or collection that shows as past due. This could be a relatively small amount of money (e.g., $80), but it may be costing you thousands when you go to borrow on your home mortgage, as it is keeping your credit score down and affecting your rate.
There is a lot that goes into the credit scoring algorithm, but I’ve provided some tidbits here to help you get on track. My best advice is that when it comes time to shop for a home, get pre-approved as early as possible in the process. If you have a strong loan officer who understands credit and has access to credit scoring tools, he or she can discuss with you many ways to improve your credit, so that when it comes time to borrow you are positioned for the best terms available in the marketplace!