Credit Score Part 2: Improving Your FICO Score

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In my last post I focused on understanding and tracking FICO credit score. In this post, I am excited to share with you some of the (easy) ways to improve your score. Hopefully you can strengthen your score over time and lower your interest rate on your mortgage and improve your financial health.

Remember from my last post, under the Equifax credit system, your score is based on five factors: payment history (35%), amount you owe (30%), length of credit history (15%), type of credit (10%), and new credit opened (10%). Out of these five factors, you can control at least four of them. Below I give you detailed tips on improving the four key factors that account for 90% of your credit score. With my strategy, even with the same income profile and greater spending needs, I was able to improve my score from 796 (very good) to 862 (exceptional).

blog-3-fico

Source: Equifax, Citi, and Finance Cappuccino

Tip #1: Improve “Payment History” Factor Always Pay Full Balance on Time

Misconception: Paying the minimum amount due each month is good enough.

Among the factors determining your credit score, having a pristine payment history is the most important, accounting for 35% of the score. This is also the factor that is most within our control. My recommended approach is to pay the full credit card balances on time or before the due date.

One good way to always pay mortgage and credit cards on time is to set payments on autopay. Most lenders give you that option online. Simply create an account and set payments on autopay. Funds will be deducted automatically from your checking accounts on the payment due date. Make sure you are paying the FULL amount and not the minimum payment due. Do not fall asleep during this step as it is easy to click on the wrong button and inadvertently select the wrong option. Once you receive a confirmation, go back to the account and check.

In today’s (still) low interest rate environment, we are getting almost 0% interest on our checking accounts so if you have the cash, I would recommend paying off the balances early.

Tip #2: Improve “New Account Opening” Factor Open New Accounts Sparingly

Misconception: Fewer accounts are better; don’t apply for new credit that you don’t need

When you are reviewing your credit report and notice that your scores are lower than what you expected even though you pay all balances off on time, a common culprit is that you have too many new accounts open. Having too many inquiries in your credit report could temporarily lead to reductions in your credit score. I would recommend opening accounts sparingly and try to group them around the same time to minimize the exposure of credit inquiries. This is especially important if you expect to be shopping for mortgage rates in the near future.

Having few accounts does not necessarily mean higher credit score; having more accounts can have positive effects as well. I will discuss more in detail in Tip 3. To give you an example, my dear husband and I have many shared accounts and our credit profile are similar. However, I have more than two times the number of credit cards open than he does, yet I have consistently had higher credit score.

In short, I think it is ok to have new and more accounts as long as you are opening them sparingly and for good reasons. After all, the “New Account Opening” factor only accounts for 10% of the credit score. I typically open new credit card accounts to take advantage of account opening bonus, higher rebates, or merchant discounts. I will do a separate post on the best small business and individual credit cards at a future date.

Tip #3: The “Amount You Owe” Factor – Aggressively Pay down Your Credit Cards

Misconception: You can’t change amount you owe

One key ratio that determines 30% of your credit score is Credit Utilization, which is equal to the amount you owe divided by total credit capacity. The smaller your utilization, the better your credit score.

Ideally, you want a small numerator (amount you owe) and big denominator (total credit capacity). The amount you owe is a function of your spending and total credit capacity is a function of the total credit limits for all your credit cards.

To raise your credit capacity, you need to have enough credit cards (see Tip #2). Remember if you apply for new cards, please do so sparingly (and only if you are also getting a financial incentive). However, over time you should be able to build up your total credit capacity.

To lower my credit usage, I pay all of my credit cards once or twice per week. My average credit balances are near 0 and sometimes even going into the negative territories.

As an example, say I owe $200 on my Citi credit card, I would pay $500 (effectively overpaying) and let my balance be -$300. It will take sometimes before my balance becomes positive again so I don’t need to pay on a daily basis. Note that Chase puts a limit on how much you can overpay. I like the Citi system better since I can freely overpay any (even larger) amounts.

To reduce the hassle of logging on and off on a computer, I prefer to use the Citi iPhone app. I can log into my account when I have a few minutes between meetings to get this done. If you have joint account owners, they can free-ride on your efforts of paying frequently.

Tip #4: Improve “Length of Credit History” Factor – Borrowing Someone Else’s Credit History

Misconception: Credit history must be your own.

This point is especially relevant to family members, e.g., children, who do not have lengthy credit histories. If you (the parent) have a long-standing higher credit score and a teenager without a lengthy credit history, you have two options:

1) Apply for a new credit card in your child’s name and add yourself as a guarantor, OR

2) Add your child to your existing card

Which would you choose?

blog-3-kids

Source: Finance Cappuccino

My recommended option is number two. With option number one, you child starts a new credit file and builds her credit history from scratch. But if you have a long credit history, and you are ok with paying all the expenses on the card, it would be much better to let your child automatically gain your decades-old solid credit history. Pick the card that you had the longest credit history and let your child piggyback on that. This will give your child a jump start in building her credit history, and may help her get a terrific mortgage rate in the future.

Dear readers, I hope the above tips are helpful. What is your credit score improvement strategy? Are you focused on getting a top credit score for yourself and your children?

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