I currently have 15 credit cards.
Over the last 5 years, I’ve opened 35 of them.
My credit score is 825.
If you read that, and you reacted with surprise, shock, or you’re judging me right now…this is for you. First, we’re going to bust some credit myths, and then I’m going to give you four straightforward ways to improve your credit. If you catch yourself saying ‘I didn’t know that,’ then please share this article, because I know from hundreds of client meetings that you’re not alone.
We all know our education system does not prioritize financial literacy; I bet you could rattle off a lot of state capitals, but you couldn’t break down your credit score. With apologies to my junior high geography teacher, good luck getting a mortgage by proving you know where Topeka is.
Credit scores are murky; they were designed as a proprietary product of one company. As the US became a consumer culture and buying on credit became common, lenders needed a way to ‘score’ us. In 1958, the Fair Isaac Corporation (FICO) introduced the first credit scoring system. In 1991, FICO released its ‘FICO risk score’ to the three major credit bureaus, Equifax, Transunion, and Experian…100 billion scores later, FICOs are used in 90% of consumer lending, and are a ubiquitous part of our financial system.
Along with a rapid rise of credit usage came an equally rapid rise of misinformation. People knew they had a score, but they weren’t always sure what it was, where it was, or how it was computed. Myths began to form…but the proprietary nature of the FICO score kept truth in short supply. People tended to learn about credit from their parents, which often meant (bad) credit habits were passed down to the next generation. No one ever taught us how to do it right.
Before I give you some tactics to improve your score, let’s look at what makes up your score, and bust some myths:
Myth: If I get a better job, make more money, and have a house and car, my score will go up.
Truth: No, no, no. Your credit isn’t dependent on how much money you make or your job title. The credit bureaus, mortgage lenders, etc, are more interested in how you handle the credit you have. This myth applies for age, marital status, etc, etc – they don’t matter.
Myth: As long as I pay for everything in cash and never use credit, my score should be excellent.
Truth: Nope. Look, if you can go through life and pay for every single thing with cash, you should do that. How realistic is that? An excellent score depends on your consistent, responsible use of credit. If you never apply for any, and never use any, lenders can’t ever know for sure how you’ll handle it when you do.
Myth: I have these old credit cards lying around, I should just close those to improve my credit.
Truth: Absolutely not. Your ‘Length of Credit History’ is the amount of time since you first opened an account in your name, and your ‘Amount of Debt’ depends on having credit available. If you close all your old accounts, you’ve just shortened your Length of Credit and affected your Amount of Debt, and that’s going to lower your score.
Myth: I don’t want to pull my credit report because it will count against my score.
Truth: When you access your credit report it’s considered a ‘soft pull.’ It doesn’t affect your score. On the contrary, you should be reviewing your credit report at least annually.
Myth: I don’t want to shop around for different mortgages because it will lower my score.
Truth: These are considered a ‘hard pull’ of your credit and it does briefly lower your score, but the credit agencies know when you’re shopping. If they see a bunch of mortgage lenders showing up all at once, they lump that together as just one ‘hard pull.’
Myth: I don’t monitor my credit because it costs money.
Truth: Not anymore! In 2003 some politicians realized how ridiculous it was that our scores were ‘hidden’ from us, and passed a law that required the 3 credit agencies to make your report available once per year, for free. See below for more info.
Myth: Applying for new credit cards will ruin my score.
Truth: Wrong. This is the biggest misconception I’ve found, and one that is hurting a lot of scores. Why? Let’s explore…
The biggest contributor to your score should be obvious: Payment History. There’s no solution or secret sauce here; you have to pay your bills on time. If you’re late, or worse, get sent to collections, that’s going to significantly impact your score. That’s number 1, fix that first.
So let’s assume you pay your bills on time. What else can you do to lift your score? Here are 3 more ways to help immediately:
2. Don’t close those old cards! Length of Credit is 15% of your score. It looks at your oldest account, your newest account, and an average of all of them. Unless you’re paying a huge fee to keep a card open (that’s another topic altogether), it makes no sense to close it.
3. Get your credit report and check for inaccuracy or error. You can obtain your report once/year at annualcreditreport.com. The process to remove something is sometimes arduous, credit agencies aren’t exactly quick to respond, but you should contact all three in writing and ask for the error to be removed.
4. Finally the easiest way to increase your score: Amount of Debt (again, assuming you pay your bills on time). This makes up 30% of your score, and can be manipulated fairly easily through new habits.
Let’s spend a second on this last one.
Amount of Debt is also known as Credit Utilization. Here’s the simple equation that matters:
This ratio should be low; Less than 10%, but not zero. Ideally you’re not spreading the ‘Used’ portion over 20 accounts.
Remember, they’re looking for regular, responsible use of ‘Revolving’ credit. Revolving credit is the kind where you choose the amount, vs. ‘Installment’ credit, which are fixed payments that must be paid monthly, like a mortgage or car loan.
Now let’s look at an example: If you have two credit cards, each with a $10,000 limit, and you spend $5,000 on one card, here’s how that’ll look:
Even though you may regularly pay off your $5,000, and feel like you’re using your credit well, the credit agencies will view this percentage as too high and penalize you for it.
How can you fix this? Well the easiest way is charge less each month, but what if you’re earning points or miles for that $5,000?
The other way is to apply for more credit.
Disclaimer: if you’re thinking of applying for a new credit card, but you also struggle with #1, then stop what you’re doing, delete this article, and go make a budget. Managing credit cards requires that you have the discipline to pay your bills in full every month.
Let’s be clear: applying for credit and a new card does negatively affect your score…but only at first. From the pie chart above, 10% of your score is New Credit, but Utilization Rate is 30%, and 30% > 10%. What you’re doing is trading a temporary deduction in the 10% category for a permanent boost in the 30% category.
Find a credit card that’s free and provides a good point/bonus system (more on this in a future post). Let’s say you’re approved and get a new card with $10,000 more in credit…from our example above, now your monthly Utilization looks like this:
After about 6 months to a year, the negative hit you took in ‘New Credit’ will disappear, but the boost you got from Utilization will remain.
Voila – a higher score!
In summary, if you don’t really understand how your credit works, trust me, you are not alone. Now you have no excuse not to squeeze out a higher score! Here are those steps again:
- Pay your bills on time!
- Don’t close those old cards
- Review your reports annually at annualcreditreport.com. Report inaccuracy!
- Decrease your utilization percentage by increasing your Credit Available
More education is desperately needed on this topic, so please share this with a friend or family member,…and maybe even that geography teacher!