Credit 101 – What to Know and How to Improve It

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You may be wondering how to fix your credit or how to improve your credit rating. It takes time, but the best way to improve your credit is by being a responsible borrower.

The first step is to know what’s in your credit report and to make sure there aren’t any mistakes. The next is to pay down your debts and keep them paid down. These seven tips will help flesh out the how-tos of following those two steps.

1. Check your credit report.

You are entitled to one free credit report per year from each of the major credit reporting agencies, Equifax, Transunion, and Experian. AnnualCreditReport.com, authorized by the Consumer Financial Protection Bureau (CFPB), is a one-stop source for your free credit reports. You don’t have to get all three at once. If you get one every four months so you can monitor your credit report throughout the year.

The CFPB also has information on getting reports from more specialized credit reporting companies.

Make sure the information on each report is accurate, especially your name, address, and social security number. If there is inaccurate information in your credit history, dispute it with each agency that has the error. Give them the correct information and ask them to correct their report.

The free credit report won’t include your credit score, but you may be able to get it through your credit card company or other sources.

2. Keep credit card balances low or paid off.

One factor in determining your credit score is how much credit you have compared to how much you’re using. Keep your usage below 30 percent, so if you have $10,000 available, keep your total usage below $3,000.

One way to keep your usage low is to pay down your balances. A common technique is to pay off the smallest balance, then add the money you were paying on that to your payments on the next smallest balance, and so on until you’ve paid off your debts.

3. Don’t close paid-off credit cards.

Unless it has an annual fee, or there’s a penalty for not using a card for a period of time, or using it is too big a temptation, don’t close a card you’ve paid off. Since part of your credit rating is determined by the percentage of credit you use compared to the credit available to you, the unused credit on your paid-off card will lower the percentage of credit you’re using.

If you do close a card, ask the credit card company to put a note in your credit report that it was closed at your request.

4. Don’t take old debt off your report.

This may seem counter-intuitive, but a record of well-managed debt, of regular payments made on time, can show lenders you are a responsible borrower.

5. Keep your time-span short for major purchases.

Applying for a loan can drop your credit score by as much as 5-10 points because it means you’re looking to take on more debt, which means more of your income goes to pay off debt each month, and lenders want to make sure you can handle the extra payments.

For some loans, you may make several applications, searching for the best rates or terms, but only take out a single loan. Each application could drop your credit score by those 5-10 points, but credit reporting agencies make allowance for the fact that you’re only taking out one loan—at least for car loans, student loans, and mortgages.

The widely used FICO credit score ignores inquiries made for these three loans in the 30 days before scoring. (If your credit card statement includes your FICO score, customer service may be able to tell you when the scoring period is.)

For these three types of loans, the FICO score will treat inquiries older than 30 days as a single inquiry if they’re made within one shopping period. John Ulzheimer, formerly of Equifax and FICO, told Bankrate.com that the shopping period depends on what scoring software lenders are using. For the newest software, the period is 45 days, 14 days for older software. Ask your lenders if the software they’re using allows for a 45 day shopping period.

6. Pay bills on time.

If you have several bills due around the same time every month ask your lenders about changing the due date, especially if your payday changed because you got a new job, or for some other reason.  

7. If you don’t have a credit card, get one.

Lenders like to see a mix of loans, which shows that you can handle different kinds of credit. A credit card with a low balance, or one you pay off each month, can build your credit history and further demonstrate how responsible you are as a borrower.

To paraphrase the old saying about interest, those who understand credit use it wisely, those who don’t pay higher interest rates. Monitor your credit reports and make sure the errors get fixed, pay down your balances, and pay your bills on time. These steps should help you boost a good credit score, fix a bad one, and improve your credit rating overall.