How to Increase Credit Score
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Most New Year’s resolutions require consumers to spend money, but here’s one that actually doesn’t cost anything and ultimately helps people save: Boost your credit score.
Low credit scores result in higher interest charges for all types of debt, including credit cards and home loans. Borrowers with a FICO credit score (the score used for most consumer lending decisions) of 700 save an average of $648 in interest on their credit card, $1,392 on their car loan and $2,340 on their mortgage each year, compared with borrowers who have scores below 620, according to a study by CardHub.com , a credit-card comparison website. Those savings get even larger for borrowers whose credit score is above 700. Separately, lower scores can lead to larger home and car insurance bills and make it harder to rent or buy a home.
Fortunately, there are ways to improve a low credit score and most involve scaling back on credit-card usage. That’s because in the world of credit scores, all debt is not treated equally. FICO scores tend to drop as consumers rack up more credit-card debt but don’t decline as much if someone signs up for a student loan, car loan or mortgage. Here are five steps to improving your credit score.
Pay down credit-card debt
To improve their credit scores, borrowers need to lessen their credit-card debt.
Once a borrower surpasses a 10% “credit utilization ratio” — that is, the amount of their credit card debt in relation to their total spending limit — their FICO score will likely drop, says John Ulzheimer, consumer credit expert with CreditSesame.com, a credit-management site, and a former manager at FICO. For instance, borrowers whose credit-card spending limits total $10,000 should not surpass $1,000 in debt — whether or not they pay off their balance in full each month.
That can be an onerous task for many borrowers. They’ll need to adhere to stricter limits if they want the highest score possible. According to FICO, borrowers with the best credit scores — of 785 or greater — use an average of 7% of their total credit-card limit. In contrast, student loans, car loans and mortgages are not considered by the credit-utilization ratio.
Consumers can consider asking their card issuers to increase their credit-card limits, which could in turn increase their credit score. Of course, that will require not swiping for more purchases on those cards.
Convert credit-card debt to personal loans
Borrowers with a lot of credit-card debt aren’t out of luck. They can actually improve their score before they even pay down their debt — with a bit of strategizing: They can consider rolling their credit-card debt into a personal loan.
Here’s why: Credit-card debt tends to be more damaging to credit scores than a personal loan, which is considered installment debt. The credit-utilization ratio (see previous section) does not take installment debt into account. This strategy would result in zero dollars of credit-card debt on the borrower’s credit report, which could boost their score by 100 points or more, says Ulzheimer. They’ll also pay lower rates to boot: The rates on personal loans currently average 11.36%, according to Bankrate.com. In contrast, rates on credit cards average just over 13% to 15.4%.
This strategy will only help borrowers if they stop using their credit cards or if they pay off the charges they make on their card quickly. Otherwise, their score won’t stay up for very long. Of course, consumers should pay off all their credit-card debt with their savings rather than signing up for a loan. But that assumes they have enough cash set aside after paying this debt for their emergency fund. (Financial advisers typically recommend people have savings equal to six to eight months of living expenses in a savings account.) More at 5 ways to boost your credit score