This guest post was written by Jason Bushey. Jason is a personal finance blogger and the Editor of Creditnet.com, an online authority on credit repair and comparing credit cards.
“What’s up with my credit score?”
It’s a reasonable question, especially the first time you check your credit score. If you see a low number staring back at you – 680 and below – then you’ve got a little bit of work cut out for you. It’s also a good opportunity to ask why your credit score is … well, the way it is.
If you want the best possible interest rates – be it on auto loans, a mortgage or future credit card offers – you’ll want to nudge that credit score from just OK to good and even excellent. And in determining how to improve your credit score, it’s imperative to understand what your credit score is made up of.
OK, here’s what’s up with your credit score.
First, if you’ve ever skipped a credit card payment entirely or made multiple late payments, then yes, your credit score will suffer for it. The inventors of the FICO score (the score you’re probably looking at) have said time and again that the biggest factor in determining your score is your payment history. Every time you make a credit card, loan or mortgage payment on time, you’re helping your score. And every time you miss one of these payments … well, you’re hurting it significantly, along with your chances of future creditor approval.
Second, if you’re carrying a high balance on some or all of your credit cards, you’re doing further damage to your score. Those same FICO inventors have said that the second biggest factor determining your score is your credit-utilization ratio, which is essentially the amount of debt you owe relative to your total available credit line. The guys and gals at FICO are super helpful, and will even go so far as to tell you how much debt you’re allowed to keep without negatively affecting your score; 30 percent, though 10 percent is ideal. Keep your credit card balance as low as possible; it’ll save you money on interest in the short and long-term.
There are several other smaller factors that play a role in calculating your score, but those are the two biggies. And if the above issues sound like they could be wreaking havoc on your score, there’s an easy way to start repairing that score, and it begins with applying for a new credit card.
That’s right – credit cards, when used correctly, can be extremely helpful in your journey back from “meh” credit. There are credit cards to repair credit aimed at various credit levels, from the bottom of the barrel to so-so, and even those scores bordering on fair or good.
How do they work? By targeting the above issues directly, namely improving your payment history and extending your credit line.
Applying for a new credit card gives you another opportunity to improve and expand your payments history. For instance, if you only had one card previously and up the ante to two, you could double the amount of payments you make each month. That means you’re improving your payments history at twice the rate you were previously, which is no small feat when you think about it.
If your credit is good enough (in the mid-to-upper 600’s), you might even get approved for a credit card that applies 0 percent interest for a temporary period of time on balance transfers. These cards can help you pay down your debt interest-free by literally transferring some or all of the balance on your old card and applying it to a new card. It’s the equivalent of refinancing your credit card debt, basically.
Paying down your existing debt is crucial to repairing your credit score because it lowers that all-powerful credit-utilization ratio, which is the second reason using a new credit card responsibly to get your score in order is a good idea: a new card extends your credit line.
If you go from owing $350 in credit card debt with a total available credit line of $1,000, to $350 in debt and a total available credit line of $2,500, you just lowered your debt-to-credit ratio considerably. (Note that credit lines vary, but this example assumes a new credit card limit of $1,500.) That’s yet another way in which your shiny new card can help you improve your credit.
To sum it up, building your credit is simple but it does take time and a little action on your part. The trick is to know what makes up your score and how to use a credit card intelligently and to your advantage. (And if you made it this far into the article, then you should be good to go!)