If you are planning to apply for a mortgage any time in the near future, it is time to start cleaning up your credit score. A credit score is not the only factor lenders take into consideration when deciding whether you qualify for a home loan. Nevertheless, it doesn't only determine whether a lender wants to work with you, but can also affect the amount of interest you'll pay on a loan.
If you take the proper measures, fixing a bad credit score is definitely possible. First and foremost, it is key you understand exactly what determines that score.
What is a credit score?
A credit score is a number that reflects how trustworthy you are to pay off your debt. While scores can be calculated a few different ways depending on the service used, here are a few common elements factored into your credit score:
- Payment history - do you pay your bills on time?
- Number of open credit lines
- Debt you owe
- Utilization ratio - how close do you come to reaching your credit limit every month?
Your score is determined based on the information provided in your credit report. It is reflected as a three-digit number, the higher the better. The Consumer Financial Protection Bureau said FICO scores are most commonly used by lenders.1 In addition, there are three credit reporting agencies: Equifax, Experian and TransUnion. The majority of lenders will take your score from each agency and use the middle one as the determinant of your interest rate.
It doesn't take as long as you might think to fix a bad credit score. What it does take is increased financial responsibility, but there are also a few practices you may not even realize could affect your score. Here are a few ways to start cleaning it up:
1. Order a copy of your credit report
The first thing you need to do to boost your score is understand it. Order a copy of your credit report and dissect it thoroughly. According to Forbes contributor Curtis Arnold, each of the three credit reporting bureaus are required to provide you with one free copy of your report every year.2
Once you have a copy, read it carefully to make sure all of the information is accurate. If you note any errors, dispute them. Time said that every credit bureau has an online form where you can submit a dispute.3 You can also directly contact the lender or creditor responsible for reporting an inaccuracy. When an error is fixed on your credit report, your score can improve right away.
2. Don't make late payments
Whether or not you pay your bills on time is the most significant factor in determining your credit score. Arnold explained that FICO considers payment history as 35 percent of your score. One obvious way to make sure you pay your bills on time is to not spend more than you can afford to pay back. Beyond that comes the task of simply remembering to pay the bills. Online banking makes this incredibly easy. You can set up automatic payments or at least schedule text and email reminders to alert you when payments are due.
3. Lower your utilization ratio
A utilization ratio, expressed as a percentage, reflects the amount of money you spend per month as compared to your credit limit. According to Time, it is the second-most important factor in deciding your credit score. Lenders don't want to see you almost max out your card every month, even if you pay your bills on time. They want to see you spend responsibly. A good utilization ratio is 30 percent or lower, though people with the highest credit scores keep their ratio at about 7 percent.
ABC News said one way to keep your utilization ratio low is to pay your bill more than once a month.4 The more you return your balance back to zero, the further you will remain from reaching your credit limit.
4. Don't get too many credit cards
Opening too many lines of credit, especially in a short amount of time, can hurt your credit score. ABC News said doing so is a red flag and makes you appear less financially responsible. Obtaining a new retail credit card is also more detrimental to your score than obtaining a traditional card, so make sure to carefully consider the risk before letting the salesperson behind the counter convince you the loyalty points are worth it.
5. Start establishing a credit history
Your credit score reflects the frequency with which you pay off your debt on time. If you have not had a credit card for very long, you will not be able to demonstrate a history of responsible spending and on-time payments. Time stressed the importance of establishing a pattern so lenders know you are trustworthy. Even if you are not planning to buy a home in the near future, it may be a good idea to start building credit now. You'll be grateful someday down the road when you receive lower interest on your mortgage payments.
6. Don't cancel credit cards
Arnold explained that canceling a credit card can actually hurt your credit score because it reduces the amount of available credit you have. According to FICO, a canceled credit card doesn't even disappear from your credit report.5 It could still be factored into your score, so better to keep it active and spend responsibly.
1Consumer Protection Bureau