As a kid, were you ever threatened to have something placed on your “permanent record”? I genuinely believed every person had a record like this that followed them around for life, including things like how many after-school detentions they got and how many times they’ve littered. I was oddly okay with it.
Later, I realized there is no such permanent record, but there are a few documents that come close. One of them is your credit report.
Credit scores are a way for institutions to gauge your creditworthiness or the risk that you might fail to pay your debts. Your credit score can determine if you can secure a loan, of course, but it can also determine whether you can get a cell phone contract, an apartment without a co-signer, or even a job. Yep, the use of credit reports for employment screening is allowed in most states.
For something so important, it’s surprising how many people ignore their credit reports. The National Foundation for Credit Counseling discovered that three out of five adults had not reviewed their credit score within the previous year; 65 percent hadn’t even looked at their credit reports.
I get it — credit reports aren’t particularly interesting — but it’s important to know what’s on there anyway.
One reason to read it? It might be flat out wrong. A Federal Trade Commission study found that 20 percent of consumers have errors on their reports. For one out of every 20, the errors could even mean having to pay higher interest rates for things like mortgages. If you find something strange on your report, you have a chance to get it taken off. If you never look, you’ll probably never know and might end up paying more than you have to.
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Where To Get Your Credit Report and Credit Score
Americans can get a free credit report every year from each of the three credit bureaus (Experian, TransUnion, and Equifax), but we aren’t entitled to receive a free score. However, there are still ways to get your hands on that information for free.
Credit scores are made available by subscription by one of the many credit report monitoring services, although they often ask for your credit card information and charge you a monthly fee after the trial expires. Gross.
CreditScoreCard.com by Discover provides a free score with no credit card required (Forbes goes more in depth on this service). Sometimes banks or credit card companies will provide your credit score free of charge, as well–I get mine on my Discover statement each month–so check with your bank and credit card companies to see if they offer this service.
There are several different methods of calculating credit scores, and they vary by country. Even within countries, there can be several systems in place to monitor creditworthiness. Because I don’t have a degree in Personal Finance and don’t expect you to, either, I’ll keep it simple and base my advice on what I know about the most common model in the United States: FICO.
The FICO credit score ranges from 300 to 850 (higher = better), and it’s broken down like this:
35 percent is based on your payment history.
This includes everything from a late credit card payment to foreclosures, liens, and bankruptcy. Basically, this is all the negative stuff on your record.
Improve your score: The best way to keep this portion of your score high is to make sure you make all payments on time and don’t take on contracts or debt that you can’t handle. Setting up auto-pay on all your credit accounts is an excellent way to prevent late payments.
30 percent is based on your debt burden.
This category is more complicated than your debt to income ratio. It also includes debt to limit ratio (how much of your available balance is used up), the number of accounts with balances, the total amount owed, and how much is paid down on installment loans.
Improve your score: You can improve this measure by never maxing out a credit card (or any other type of revolving credit). If you need to carry a balance from month to month, try not to let it get higher than 30 percent of your total credit line.
15 percent is based on the length of your credit history.
As your credit history becomes longer (“ages”), it has a positive impact on your score. The age of your oldest account and the average age of your accounts are included in this category.
Improve your score: There isn’t a quick fix for this portion of the score, but you can optimize it by keeping your oldest account open (even if you don’t use it) and trying not to open too many new accounts.
Pro-tip: make sure the account won’t accrue any fees while it’s not in use.
10 percent is based on the types of credit you use.
There are several types of credit, and it’s best to have a mix of the different kinds. However, there isn’t a magic combination of account types that will improve your score. My advice here is to only open accounts you can afford as you need them.
The last 10 percent is based on recent “hard inquiries” for credit.
When you apply for a credit card or loan (revolving or otherwise), it’s called a “hard pull”. These can hurt your score, especially if there are a lot of them. The good thing is that the FICO model considers hard inquiries that occur within 45 days of each other as only one credit inquiry, so you can still feel free to shop around for the best loan rates.
Credit inquiries that you make (like pulling a credit report to check on it) or by a potential employer do not have any impact on your score: these are called “soft inquiries,” and don’t appear on the credit report that lenders use.
Now that you can see all the factors that FICO uses, you can see that there are no quick fixes when it comes to your credit score. A lot of the improvement comes with being a consistently responsible (i.e., bill-paying) borrower for an extended period of time.
Slow and steady wins the race. If you stick to the advice here, though, you’ll more than likely see an improvement in your credit score within the year.
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