Understanding Your Credit Score (Part II)

In our first article (see Understanding Your Credit Score - Part I), we discussed credit reporting and what activities impact your credit score. We pick up from there with more information on how to potentially improve your credit score, the importance of reviewing your credit report, and how (and why) to freeze your credit.

Opening many new accounts within a short period of time can temporarily hurt your credit score, even if your immediate goal is to spread revolving balances to lower your utilization rate and create a better mix of account types. The message around credit is “Don’t overdo it!” Moderation is key!

Of course, many people want to know how they can establish good credit, or improve their current credit score. The single best piece of advice is to pay your bills on time…every time. You can do this by setting up automatic payments, or electronic reminders. If you’ve missed payments, get current and stay current.

Other ideas to help you improve or maintain a good credit score include:

• Stay away from your credit limit
  • Credit scoring models look at how close you are to being “maxed out.” So try to keep your balances low in proportion to your overall credit limit.  
  • Experts advise keeping your use of credit at no more than 30 percent of your total credit limit. 
  • Paying off the balance of your credit card each month helps get you the best scores.
• Only apply for credit that you need 
  • If you apply for a lot of credit over a short period of time, it may appear to lenders that your economic circumstances have changed, negatively.  
  • Just because a retailer offers you a credit card, doesn’t mean you should apply.
• A long credit history will help your score
  • Credit scores are based on experience over time.
  • The more experience you have with getting credit and paying your bills on time, the more information there is to determine whether you are a good credit risk.  
  • Younger people can begin to establish their credit with wise use of their first credit cards, or car or student loans.

Your good credit habits are reflected on your credit score for ten years, or even longer. The same is true for bad credit habits. Therefore, it’s important that you are also aware of factors that will lower your credit score. Here are some examples, a few of which we mentioned above:

• Missing payments or making late payments
• Having home foreclosures
• Going over your credit limit on credit cards
• Receiving collection notices
• Declaring bankruptcy
• Applying for credit too frequently in a short amount of time
• Having a poor debt-to-credit ratio – meaning close to having ‘maxed out’ your credit cards

It is important to note that various lenders view these factors differently. Regardless, many of these factors will stay on your credit report for approximately seven years. However, bankruptcies and unpaid tax liens can stay on your credit report for up to ten years.

It is a good idea to check your credit score no less than once each year. Once every 12 months, you should request a free copy of your credit report from each of three major credit reporting agencies – Equifax^®, Experian^® and TransUnion^® – or from AnnualCreditReport.com.

When reviewing your credit report, check that it contains only items about you. Look for information that is inaccurate or incomplete, such as addresses of places where you did not live and names of employers for whom you did not work. Also look for information that should no longer be on your credit report, for example a bankruptcy that is more than ten years old. 

If you find errors, you should contact the credit reporting agency from whom you obtained the report, and the creditor or whoever provided the information (called the “furnisher” of the information). The copy of your credit report will include information about how to dispute inaccurate or incomplete information.

In general, credit scores are used to help lenders determine whether or not to grant you additional credit. Since credit scores are consistent and objective, they help lenders assess risk more fairly. By checking your credit report at each credit reporting agency annually, and by following the guidelines outlined above to build and protect your credit, you increase the likelihood that you will be approved for future credit at a favorable rate.  

Resources:
•    Annual Credit Report – www.annualcreditreport.com  
•    Consumer Finance Protection Bureau – www.consumerfinance.gov 
•    Equifax – www.equifax.com 
•    Experian – www.experian.com 
•    Federal Trade Commission – www.ftc.gov   
•    Transunion – www.transunion.com

Read the Financial Planning Focus August 2022:

• "School Daze" by Cheryl Langston, CFP^® »
• "The Millennial's Guide to Budgeting" by Rick Gibson, CFP^® »
• "When the Market Gives You Lemons…" by Matt Cohen, CFP^®, CIMA^® »

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