STEP 1: Understand how a credit score is calculated
The first step is to understand how credit bureaus calculate credit scores. The credit score calculation is comprised of five different components. Those are:
- Loan and credit card payment history
- The amount of debt you have
- How old your credit history is (this is referred to as “age of credit.”)
- Types of credit you have (i.e. credit cards, loans, etc.)
- Outstanding and recent credit (i.e. what you owe currently in loans and other finance or have applied for)
It is important to try to have a good mixture of credit, split equally between cards and loans. This is known as diversifying your credit portfolio. It can help your credit score as you receive points for have a good repayment history for multiple sources. It suggests to lenders that you are an appealing borrower for many products, so you stand a better chance of receiving the more preferential rates.
STEP 2: Maintain a good credit repayment record
Once you understand the components of a credit score, you can see why it is important to repay you credit cards, loans and other financial obligations on time – outstanding and recent credit is given a significant weighting in calculating the overall score. Paying your utility bills on time or early is also another important aspect of maintaining a good credit repayment record – something seemingly small as a couple of late cell phone bill payments or a late cable bill can actually very quickly start to deteriorate your credit score with what are called records of default. Another motivator for paying your credit obligations and bills on time or early is to avoid the dreaded and expensive late payment charges that may be levied. Late and missed payment penalties are notoriously high and the record of the missed or late payment can adversely affect your credit score by suggesting to creditors. Pay on time and give the right, responsible message to future creditors.
STEP 3: Stay in control of debt
Debt needs to be manageable in order to be repaid on time and to impact your credit score in the right way. Perhaps somewhat surprisingly, having a small amount of debt that is repaid on time and to a good ratio is better for your credit score versus repaying everything off each month. Keeping your credit card balance low is proven to give credit scores a boost by demonstrating to creditors that the borrower understands how to manage their debt effectively. It is also advisable to keep the number of loans and credit cards that you have active to a minimum.
This is because some creditors view borrowers with numerous credit cards with medium to high balances as high risk borrowers.
STEP 4: Keep old credit card accounts open
Many personal finance experts recommend that consumers should keep old credit card accounts open once paid off, rather than close them down. The trick is to use them every once in a while for small purchases that will be paid off in full at the due date. If you close these cards down, the credit bureaus will not receive reporting information on them. The cards will be marked as inactive, which can negatively impact your score. Remember that all reporting information that is positive (i.e. paid on time, no late payments) helps improve and maintain good credit scoring criteria.
STEP 5: Keep your application for credit to a minimum
You will have seen that credit applications also form part of the credit score calculation. In fact, credit inquiries contribute to 10% of your overall score. If you complete a number of credit applications in a short period of time, your credit score can be decimated. Be careful and discerning with making credit applications and remember that each time you make one, your credit score will decrease a little.
STEP 6: Keep checking your credit file
After doing all of this good work to improve and maintain your credit score, it is important to check that any mistakes recorded in your file are swiftly corrected. The law entitles you to one free credit report from each of the three major credit bureaus a year.