• How to Improve Your Credit Score as Quickly as Possible

    Brandon Cornett

    By Brandon Cornett
    © 2014 All rights reserved

    The editor of the Home Buying Institute explains one of the most confusing topics in consumer finance -- credit scores and how to improve them.

    In this tutorial, you'll learn how to improve your credit score as quickly as possible. We will also discuss the credit-reporting system in the United States, as it relates to you. Lastly, we will examine the potential benefits of improving a score.

    This is one of the most common questions we get from our readers. In fact, it's one of the top two questions in terms of frequency. (The other question has to do with housing affordability.) It seems a lot of consumers want to know how to raise their credit scores. So you're in good company. Let's jump right in...

    Improving Your Score - In a Nutshell

    The fastest way to improve your credit is by using a three-part strategy. You must pay all of your bills on time, especially those items that show up on your credit report. This is the most important step, as it accounts for 35% of your score. You should also consider reducing your debt, particularly your credit card balances. Lastly, you'll need to check your credit reports for errors, and dispute those errors to have them removed from your reports.

    The green box above includes the three biggest things you can do to improve your score. As we continue through this lesson, we will talk about each of these factors in more detail.

    How Credit Reporting Works

    To understand how to improve your credit score, you must first understand how the reporting system works in the United States. Here is a simplified diagram that shows how your borrowing activity feeds data into your credit reports, and how that data is then used to create a three-digit score.

    The Credit Reporting Process

    Here's something you may find surprising. You actually have six possible credit scores, and they can all be slightly different. Why six? Because there are three different reporting bureaus in the U.S. -- Experian, TransUnion and Equifax -- and two ways to interpret their data (FICO and VantageScore). So you have a FICO score from all three bureaus, and you have a VantageScore from all three of them as well. [2012 Update: Experian no longer releases their scoring data for use with the FICO model. So, technically, you don't have an Experian FICO score -- just an Experian VantageScore.]

    Here's the good news. If you improve one of your credit scores, you will likely improve them all. The three bureaus do not share data between themselves, so your scores may be different across the three companies. But they all get their data from the same source. They get it from creditors and lenders who report your financial activity to them (banks, auto lenders, credit card companies, etc.).

    Terminology note: For the remainder of this article, I'll be referring to your FICO credit score in particular. This is the one mortgage lenders use most often, when considering you for a home loan. There are other scoring models out there, but we will limit our discussion to FICO in particular. It's a three-digit number between 300 and 850. The higher your FICO score, the better your chances of getting approved for a loan.

    What Does "Quickly" Mean?

    You want to know how to improve your credit score quickly. Following the three steps outlined below will help you achieve this goal. But what does "quickly" mean in this context? How long does it take to make significant improvements in your FICO score? I hate to pull out the 'D' word, but it depends.

    People with a long history of missing payments will have a harder time restoring their credit than a person with a single late payment. The length of your credit history also plays a big role in how long it takes to improve your credit score. So there is no way I can give you a timeline. With that being said, the steps presented below will help you boost your score as quickly as possible (given the current state of your credit history).

    You should think of it as a marathon, instead of a sprint. Credit scores fluctuate on a near daily basis. But it takes time to make significant improvements. Within the context of this article, a "significant improvement" would be an increase of 50 points or more. It might take weeks or months to accomplish this goal, depending on the variables we discussed earlier.

    The 3-Step Strategy to Improve Your Credit Score

    Let me point out that this information doesn't come from me. This is not my patented "system" for boosting a FICO credit score. This information comes from the company that created this particular scoring model. All I've done is present the information in a clear manner so you can easily understand it.

    The FICO company has listed the factors used to determine a person's FICO score. In doing so, they have also given us a blueprint for success. If you want to improve your credit score quickly, you simply need to focus on these factors. There is no mystery to it.

    Your score is determined by the following factors:

    Scoring Factor

    Weight

    Description

    Payment History

    35 percent

    This item affects your score the most. If you have a habit of paying your bills on time (credit cards, auto loans, personal loans, etc.), you'll end up with an excellent score. Learn more

    Amounts Owed

    30 percent

    Generally speaking, a higher balance on your credit accounts (relative to the limits) will result in a lower credit score. This is referred to as your "utilization ratio." It's a comparison between your available credit limit and the amount you owe.

    Length of History

    15 percent

    This is the item you have the least control over. A longer history will usually result in a better score. In most cases, your history begins when you take out your first loan, or when you open your first credit card account.

    New Credit

    10 percent

    This refers to the number of recently opened credit accounts you have, as well as the number of recent credit inquiries. If you open a lot of new accounts in a short period of time, it may damage your FICO score.

    Types of Credit Used

    10 percent

    Having installment loans and credit card accounts (and making all of your payments on time), could help you boost your score. I wouldn't sweat this one too much -- it only accounts for 10 percent.

    If you want to improve your credit score quickly, you should focus primarily on the first two items in the table above -- payment history and amounts owed. There are two reasons for this: (1) these are the items you have the most control over, and (2) these are the items that count the most toward your overall FICO score. Again, this is based on information given to us by the company that actually created the scoring model. You can't get any closer to the source than that.

    Here are some specific steps you can take to improve your score. We have covered most of this information already. Now we can get into the nuts and bolts of each item...


    Step 1 - Review Your Credit Reports

    Your three-digit score is derived from the information found in your credit reports. These reports show how you have borrowed and repaid money in the past (with creditors and lenders).

    In a perfect world, your reports would be 100-percent accurate. They would never contain false information that could hurt your credit score. But we do not live in a perfect world. In fact, the reporting industry is far from perfect. I read a study a few years back that suggested 80 percent of credit reports had some kind of error. One would hope things have improved since then. But I wouldn't hold my breath.

    Here's what you need to know. Erroneous information in your reports can drag down your score. So if you're on a crusade to improve your credit score, you need to start with the reporting bureaus. Get copies of your reports from all three companies (TransUnion, Equifax and Experian). Check them over for accuracy. Dispute any errors you find.  The sooner you start this process, the better. It may take some time to get everything straightened out.


    Step 2 - Pay Bills on Time / Eliminate Bad Habits

    If you're researching ways to improve your FICO score, I can safely assume your score is currently low. This is probably the result of bad financial habits in the past. Remember, your score is based on the information found in your credit reports -- it's not pulled out of thin air. And the reports are basically a history of how you have borrowed and repaid (or not repaid) money in the past. So you need to identify the bad habits that damaged your credit in the first place.

    Maybe you have a habit of missing credit card payments. Maybe you've maxed out a few cards in the past. Maybe you've had one or more accounts sent to a collection agency. Bankruptcy, foreclosure, debt collection, late payments -- all of these things can harm your FICO score. So take a vow, right here and now, to avoid these kinds of things in the future. Change your habits for the better, and your credit score will follow. Eventually.

    The most important thing you can do is to pay all of your bills on time. Mainly, I'm talking about the types of accounts that show up on your credit report. This includes student loans, personal loans, mortgage loans, credit cards, retail charge cards, etc. Your payment history on these accounts is 35 percent of your FICO score. In order to improve your credit score, you have to start here. Nothing else will matter if you keep missing your payment deadlines.

    Your actions have consequences. Your actions are captured within your reports, and they go on to shape your credit score. You are the only one who can change your actions. A so-called "credit repair" company cannot change your actions. A financial coach cannot change them. You must do it on your own. If you look like an irresponsible borrower on paper, your score will reflect this. If you establish a pattern of responsible borrowing, your credit score will improve. It really is that simple.

    Related reading: The Damage Caused by Late Payments


    Step 3 - Reduce Your Credit Card Balances

    If you refer back to the table above, you'll see that "amounts owed" accounts for 30 percent of your FICO score. This is your utilization ratio. This ratio shows the amount of available credit you are currently using. In other words, how close are you to reaching your credit limit?

    If my card has an $8,000 limit on it, and my current balance if $4,000, then my utilization ratio would be 50 percent. I am using half of my available credit. Generally speaking, a higher ratio will result in a lower FICO score. So it's possible to improve your score by reducing the amount of debt you owe. Obviously, this has other benefits that go well beyond scoring models. Think of the burden you'll be lifting from your shoulders, when you reduce your debt load!

    Note: There is a difference between reducing your balances and closing the actual accounts. You should certainly consider paying down your balances, in order to improve your credit score more quickly. But be cautious about closing the accounts -- this could actually hurt your FICO score.

    Be Careful Closing Old Accounts

    We just talked about the amounts owed on your various credit accounts, and how it accounts for 30 percent of your score. You'll recall that the technical term for this is the "utilization ratio." This ratio is an average of all your accounts. So if you close an old / unused card, you also eliminate some of your available credit. This could increase your utilization ratio and thus lower your score. It depends on the balance and limit of the card you are closing, and whatever cards you have remaining.

    This will make more sense if we plug in some actual numbers. Consider the following:

    John currently has three different credit cards open.

    • Card #1 has a $500 balance and a $1,000 limit.
    • Card #2 has a zero balance and a $2,000 limit.
    • Card #3 has a $1,000 balance and a $1,000 limit (it is "maxed out")

    Based on the status of these accounts, John's utilization ratio would be 37 percent. Here's how I came up with that number:

    • Total balances = $1,500 ($1,000 + $500)
    • Available credit on all cards = $4,000 ($1,000 + $2,000 + $1,000)
    • Credit utilization ratio = 37 percent (1,500 divided by 4,000)

    Let's say John chooses to cancel one of his credit cards. He closes account #2, because he never uses it. There's a zero balance on the card, so there's no point in keeping it open, right? By removing this extra $2,000 credit limit from the picture, he would change his utilization ratio for the worse. Here's what it would look like after closing card #2:

    • Total balances = $1,500 ($1,000 + $500)
    • Available credit on all cards = $2,000 ($1,000 + $1,000)
    • Credit utilization ratio = 75 percent (1,500 divided by 2,000)

    So just by closing that one card, John has increased his utilization ratio from 37 - 75 percent. This would have a negative effect on his FICO score. Bottom line: If you are trying to improve your credit score, you should be very careful about closing your old accounts.

    That's not to say you can never cancel your old cards. You are free to do so anytime you want. You just need to be careful about when you do it. If you're about to apply for some type of financing, and you're trying to boost your FICO score, you're probably better off leaving those accounts open (if they're working to your advantage).

    Related reading: Canceling a credit card account

    Improve Your Credit, Pay Less in Interest

    The first part of this lesson explains how to improve your credit score quickly. Let's shift gears and talk about the "why" factor. Why is it so important to have good credit when applying for a loan? First of all, you'll have a much better chance of getting approved for the loan. You'll also be able to secure a lower rate of interest, which could save you thousands of dollars over the life of the loan. If that doesn't motivate you to improve your credit score, nothing will.

    Let's take a closer look at the interest factor, in both a car-buying and mortgage scenario.

    1. When Buying a Car...

    Here's an illustration that shows how much money a borrower might save on a car loan, just by having a higher credit score. As you can see, a person with a lower score is typically assigned a higher interest rate on a loan. This increases (A) the size of their monthly payments, and (B) the total of amount of interest they pay over the life of the loan.

    Credit scores and auto loan rates

    This is a real-world scenario, by the way. I haven't pulled these numbers out of the clear blue sky. This data was compiled by Informa Research Services, from 2011 - 2012. It shows you, in very real numbers, how you can benefit from improving your FICO credit scores.

    2. When Applying for a Mortgage...

    Here's how it might play out on a mortgage loan. Again, this a very realistic scenario based on actual lending trends and practices. And since we are dealing with a larger sum of money here, the potential for savings is even greater.

    Disclaimer: This article explains how to improve your credit score as quickly as possible. Most of the concepts in this article come directly from FICO, the company that developed the FICO scoring model. I've just tried to make the information more accessible for you. I make no guarantees about the strategies explained in this article. Based on everything we know about the scoring models, these strategies should help you boost your score. But it's not something I can guarantee. I encourage you to conduct plenty of research before taking any measures that could affect your credit.

Improve Your Credit Score