How To Raise Your Credit Score
According to Experian, one of the three credit bureaus, the average credit score of a 30 year old is 634 (spoiler alert: that is NOT a good credit score!). Coincidentally, the average age of a first-time homebuyer is 32. So, let’s use homebuying as an example to illustrate how much a bad credit score will cost us.
I did a quick search on Bankrate for a 30-year fixed mortgage for $240,000 (the default amount on the site) in my area. A credit score of 740 will get you an APR of 3.75%, while a credit score of 679 (just 61 points lower) will land you an APR of 4.25%. Is 0.5% really that big of a deal? Well, let’s see.
740 credit score
Mortgage: $240,000
Monthly Payment: $1,111.48
Total Interest Paid: $160,132.80
679 credit score
Mortgage: $240,000
Monthly Payment: $1,180.66
Total Interest Paid: $185,037.60
A monthly payment of roughly $70 more each month may not seem like much, but take a look at the difference in the total interest paid over the life of the loan. A whopping $25,000!
Now, let’s say instead of having to pay an extra $70 a month toward the mortgage, you made monthly deposits of $70 into an online savings account earning 1.40% in interest each year. In 30 years you would have $31,300!
Another option would be to invest the $70 in the market each month for 30 years. Assuming a 7% return (totally reasonable), you would have nearly $82,000!
The lower credit score could have cost us over $80,000! What!
So, what is a good credit score?
One of the most common types of credit scores is the FICO score. It ranges from 300 to 850. A score above 700 is generally perceived to be good. But you won’t be getting the best rates until you hit a score of 740.
How are credit scores calculated?
Before we dive into how to get a good credit score, we have to understand how credit scores are calculated. Unfortunately, no one knows the exact algorithm that goes into calculating those three magic numbers. What we do know is that FICO scores are based on the following factors:
Payment history
As with other things in life, past habits are pretty good indicators of future behavior. This is why your payment history has the biggest impact on your credit score. Paying your bills on time will raise your score. Late or missed payments will lower it.
I carried quite a bit of credit card debt in college, but still managed a credit score of 802. Even though I wasn’t always able to pay my cards off in full each month, I never missed a minimum payment. Autopay options and bill reminders make this easy!
Credit utilization rate
This is the total amount of debt divided by total credit available. As a rule of thumb, you want to keep this number under 30%. In other words, do not max out all of your cards!
Age of accounts
Do not close any of your accounts! Old accounts provide more data than new accounts, which in turn actually help your credit score. So even if you have credit cards that you don’t use anymore, just set them aside (or cut them up), but do not cancel them.
New credit
Applying for several new credit cards, shopping for a mortgage, and financing a car all within the same timeframe raises red flags. Always plan ahead for major purchases to ensure the best rates.
Credit mix
A nice mix of different types of credit, such as a mortgage, credit cards, and other loans is good for your credit score. This factor is not as important as the others listed above.
Just keep in mind to not lean too heavily on any one type of credit. For example, lenders probably wouldn’t want to see that all of your credit consists of cards to your favorite stores!
How do you get a good credit score?
1. Check your free credit report at one of the three credit bureaus. Identify and correct any errors negatively impacting your score. You should do this every four months.
2. Pay your bills on time. Set up autopay for at least the minimum payment amount. Enable bill reminders to go back and pay those accounts in full (if possible) and for accounts that don’t offer autopay.
3. Don’t max out your cards. Pay down outstanding balances. Remember to keep your debt-to-credit ratio at 30% or less.
4. Don’t close any accounts.
5. Don’t open more than one account at a time.
These are the exact steps I took to get a credit score of over 800. If you apply these steps consistently, you will see your score increase in just a few months. Don’t be discouraged if you think your credit score is beyond repair. Lower scores actually tend to see bigger increases!
