Column: Want to raise your credit score? Follow these two steps
Editor’s Note: Millennials aren’t the biggest fans of credit cards. While only 35 percent of adults 30 and over don’t have a credit card, a shocking 63 percent of millennials, those age 18 to 29, have yet to get a credit card, according to Bankrate. Millennials, it seems, are debt averse.
But it’d be a mistake for millennials to avoid credit cards altogether, says Erin Lowry, author of “Broke Millennial: Stop Scraping By and Get Your Financial Life Together.” That’s because credit cards are one of the easiest ways to build good credit history. Below, Lowry lays out why a good credit report is important and how to raise you credit score. You can learn more about how to get your credit score for free, how to decipher credit reports and common credit card myths in her new book, “Broke Millennial.”
Credit scores get a lot of buzz. It makes sense, because it’s a way we can easily rank ourselves against others and a benchmark for how we’re doing in our financial lives. But let’s make it real clear immediately that it isn’t just your credit score that matters — your credit report is extremely important too. In fact, the report informs the score. These two pieces that sum up your credit history are critical, because it indicates your level of responsibility to people like landlords, lenders and even potential employers (who sometimes pull a credit report).
A strong credit history also serves as an insurance policy on your financial life. A higher score equals access to superior financial products. None of us want to borrow money, but should we need to, we want to get the lowest possible interest rate and best deal. So let’s talk about how you can position yourself to always be top of the pack with your credit score.
What’s a good credit score, anyway?
There is more than one credit scoring model, but for the sake of creating a common language, we’re going to be talking about the FICO® credit score. The FICO® score range generally runs from 300 to 850, with 300 being very poor and 850 exceptional.
Your goal should be to get into and maintain membership in the 700 plus club. A credit score of 700 or higher generally unlocks the top-tier financial products. Maybe you’ll even sneak into the mythical, and exclusive, 800 plus club!
Okay, it sounds simple enough. But you may be wondering, “how do I get that 700 plus credit score?” Well, you first need to understand the factors used to compute the score.
Let’s break down the score
There are five main factors that go into creating a FICO® credit score:
- Payment history – 35 percent
- Amount owed, aka utilization – 30 percent
- Credit history – 15 percent
- Diversity of credit – 10 percent
- Credit inquires – 10 percent
Of those five factors, it’s easy to see that there are only two with which you want to be highly concerned: payment history and utilization. Payment history is pretty much self-explanatory. You need to always make payments on time. Utilization is a technical term for the amount of available credit you use. For example, if you have a $1,000 credit limit and you spent $500, then you’re 50 percent utilized.
The two-step process to building and maintaining a high credit score
It’s easy to freak out over the smaller factors of a credit score like inquiries and diversity of credit (which means having more than one type of credit — for example, student loans, credit cards and an auto loan). But you don’t need to, because you should never generate debt just to build a credit score, and those factors pale in comparison to payment history and utilization.
Step 1: Make your payments on time.
Missing a payment, even just once, can do serious damage to your credit score. Make sure you are always paying off those student loans, credit card bills and every other bill on time.
Step 2: Keep utilization at 30 percent or less.
Your goal should be to use only 30 percent or less of your credit limit. That would be $300 on a $1,000 credit limit. It doesn’t help your credit score to max out your card (even if you pay it off). The credit bureaus want to see that you can be given a credit limit and use it responsibly. Responsible behavior isn’t running up a huge bill each month.
Credit cards freak me out
I get it. Maybe you saw your parents struggle with credit card debt or you already danced with that beast yourself. Truthfully, a credit card is the simplest and really only way to build a credit score without generating debt. A basic credit card with no annual fee that you pay off every month in full won’t cost you a penny, and you’ll be building a strong credit history. It’s how I’ve built my own credit score over the years and avoided all other forms of debt.
One way to use a credit card to your advantage without risking debt is to keep it out of your wallet. Just link it to your Netflix account or another small reoccurring charge and then automate the payment for a simple way to build credit without much risk of creating consumer debt.
However, if you believe you’ll just be too tempted to generate debt — then I agree you shouldn’t gamble on creating debt just for the sake of a credit score.
I already screwed up. What can I do?
Start pumping positive information onto your report! Your negative mark will likely live on your credit report for about seven years, but it won’t carry the same weight the entire time. The older it gets and the more positive information you have getting recorded onto your credit report, the less impact it carries.
You may be struggling to even get approved for any credit products, because you either have a thin file due to no credit history or you have a low credit score due to poor past behavior. In either case, you should consider a secured credit card, preferably one with no annual fee. You’ll be required to put down a refundable deposit, usually around $200, which acts as your line of credit. Then just make one or two small purchases per month and pay it off on time and in full. When you hit that 700 plus score, you can apply for a regular, unsecured card and then close your secured card to get your refundable deposit back!
Remember, your credit score is not a trophy
It’s easy to think of your credit score as a pretty trophy you want to preserve up on a mantle to admire. You may even get so entrenched in this mentality that you’re wary about applying for a better credit card or to refinance a loan to a lower interest rate for fear of hurting your credit score. While I’m certainly not advocating you constantly apply for credit, you do need to utilize that strong credit score when it’s beneficial to your financial health. Don’t just admire the potential of what a 700 plus score can do for you. Remember: the higher your credit score, the cheaper the rest of your financial life.