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As anyone who has applied for a credit card or loan knows, your credit score is the key to unlocking new avenues of financial success. Whether it’s securing a new auto loan, opening a new credit card, or even refinancing your mortgage payment, most lenders will perform an inquiry into your credit to determine whether you have a proven track record of being judicious with your use of credit.
The connection that many borrowers fail to make, however, is that making consistent, timely payments on your outstanding debt is one of the easiest methods of improving your credit score.
The key to resolving debt and reducing overall expenses is to consistently make payments that reduce the principal (and not simply the interest) of your loans. Borrowers who have a higher credit score can receive lower interest rates when applying for loans on major purchases. When you reduce the amount of interest accrued on major loans like these, you can reduce the total size of your monthly payments (or the length of time over which you make payments). This increases the rate at which you can use your existing income to tackle debt. Needless to say, this will significantly reduce the cost of your debt in the long term and will allow you to become debt free faster.
To manage your credit score, it’s important to know what goes into calculating this number and how best to improve it. Note that improving your credit score takes time; building trust between yourself and potential creditors requires you to be faithful and consistent with your payments on debts.
Your credit score is a mixture of five key metrics, listed here in order of importance:
- Your payment history
This is the most influential factor in your credit score, so it’s vital that you develop a plan to make payments on debts and do so diligently. Not only will your credit score be penalized for late payments, but you will also be increasing the amount of interest the debts accrue, which could push your ratio of credit-used to credit available in the wrong direction, doubling the damage to your score!
- Your ratio of credit used to total credit available
The less credit you take out, and the higher your credit-maximums are in comparison, the better your credit score. This is where having large amounts of debt can hurt you; using too much of your available credit makes it more difficult to pay it off.
- The age of your accounts
Creditors like stability, so it’s generally best to only open accounts you intend to keep for a long time, and you should avoid closing accounts too frequently.
- The amount of new debt you have taken out
Every new account or line of credit you open up will slightly reduce your credit score in order to discourage borrowers from taking on too many sources of credit all at once. To improve your score, open new accounts only as necessary.
- Your credit mix
This has to do with the number of different types of credit you have, such as installment loans, credit cards, retail accounts, etc. This measure is most important for individuals who have not been using credit for very long. It’s worth noting that you should not try to game the system and open up accounts you don’t intend to use, as these accounts must be active sources of credit, and opening new accounts reduces your score slightly.
So, now that you’re armed with the knowledge of how your score is calculated...
Here are a few useful tips to help improve and maintain your score:
Check your score regularly to prevent fraud and errors
The three major credit reporting agencies have set up a website where you can request your credit report once a year. This report will show you all lines of credit and loans you have available as well as your payment history. Since you can request each report separately, it can be useful to request one report every four months to catch errors or fraud that may be lowering your score. Mark your calendar, and use this website’s free credit reports to catch fraud and errors as quickly as possible so you can initiate a dispute.
Go on a “credit diet”
If you want to improve your score (perhaps several months prior to taking out a major loan or refinancing debt), try this: set a goal for a period of time during which you will not open any new lines of credit, and during which you will focus solely on paying off your existing credit. Resisting the temptation to open a new card will not only prevent score losses from new accounts, but you will also allow your older accounts to age, improving your credit history.
If you reduce your overall credit use without closing any accounts, you will have improved four of the five metrics used to calculate your score!
Submit a statement of dispute
If your credit report contains errors, such as listing a paid debt as still unpaid, you can dispute the claim by contacting the credit reporting agency. If your claim is well documented and provides sufficient evidence, you should typically see it corrected. Sometimes, however, the change you request will be denied. If you disagree with the results of a dispute that you initiated with the crediting agency, the Federal Credit Reporting Act gives you the right to add a 100-word statement to your credit report. This is a great tool for alerting potential creditors if one of your previous lenders made what you consider incorrect claims about a late payment, and it may improve your creditworthiness in some situations.
Building trust with creditors is a vital part of fiscal responsibility and requires you to follow through on your promises to repay debt. By keeping a meticulous record of your outstanding debts, developing a plan to reduce your debts, and following through with timely payments that reduce the principal on outstanding debts, you can and will improve your access to more affordable forms of credit.