HOW CREDIT SCORES WORK (AND THE 7 FASTEST WAYS TO IMPROVE YOURS)
A credit score plays an important role in your financial life. Keeping a high credit score benefits you in many ways: lenders are much more likely to offer you credit and better interest rates, and approve you for loans as well. Long term, this can save you some significant money. Conversely, you run a greater risk of having loan applications denied with a lower score, and may have to settle for less favourable interest rates, which could have a negative effect on your ability to achieve financial stability. Let’s learn about how credit scores are calculated, how they can affect your financial decisions, and how to quickly improve them.
How Credit Scores are Calculated (and the Factors that Influence Them)
Before we dive in, it’s important to note that this article will focus on the core principles shared across credit systems worldwide. While credit scoring models differ by country, the underlying logic - risk assessment based on borrowing behaviour - largely remains the same. Therefore, the goal is to provide general - yet useful - tips that are applicable to anyone looking to understand and improve their credit score.
There are five main factors that are evaluated when calculating a credit score: payment history, amounts owed, length of credit history, credit mix, and new credit.
Payment history generally has the single largest impact on your credit. It includes whether you've paid your bills on time, how many late payments you've had, and if you’ve had them, how late they were. Making just one payment 30 or more days late can do major harm to your score, and that negative impact gets worse the further behind you fall on payments. Any foreclosures, bankruptcies or accounts sent to collections can also have severe, long-lasting financial consequences.
Amounts owed is the percentage of credit you've borrowed compared to the credit available to you. This is also known as your credit utilization ratio, and is based on the balances that appear in your credit report. It comprises the percentage of your borrowing limit you're using on your credit cards, as well as other revolving credit accounts. A higher credit utilization ratio will result in a substantial negative impact on your credit score.
The length of your credit history also plays a sizable role in determining your credit score. Statistics show that experience with credit accounts makes you better at managing debt. So, with all things being equal, the longer your credit history, the higher your credit score tends to be.
Your credit mix, or variety of credit types, is also a factor in your credit score. This can include installment credit - such as a mortgage loan, student loans, a car loan and personal loans - and revolving credit, like credit cards and lines of credit. Credit scoring systems value a mixture of these types.
Whenever you apply for new credit, it’s not just a potential sign that you may be desperate for credit, but new debt naturally raises the odds that you’ll fall behind on old debts. If you have too many recent applications for credit, this can negatively affect your credit score., as you may be dinged for entries that appear on your credit report when a lender processes your credit application.
Why Credit Scores can Change Quickly
Credit score fluctuations can be alarming - especially if there is a dramatic drop - but it’s important to think of them as a moving target. Credit scores are calculated based on the most recent credit information available, and can change on a daily basis as agencies report new data. Different organizations update at different times, and some receive your latest transaction activity sooner than others. Knowing that your score can change from day-to-day, or month-to-month, can be helpful in planning out your upcoming transactions.
Sometimes, the simple passage of time may cause your credit score to fluctuate. Depending on your level of financial activity, some information in your credit report becomes less significant as time goes on. In some cases, when negative information falls off your report, your score can change rapidly. It also takes time for your latest transactions to impact your score, and that’s often when substantial changes can be observed.
Now that we know what affects your credit score, and why, let’s focus on how to improve it quickly.
What are the Fastest Ways to Improve Credit Scores?
Review Your Credit Report
Your first step - and perhaps the most important one - is to review your credit reports for errors or inaccurate information, which can drag down your score. With identity theft on the rise, it is critical that you check your report often for issues like fraudulent accounts or higher than expected credit card balances. If you find something that doesn’t look right, take action by disputing the information in question with the relevant agency or company, and initiate an investigation. It’s quite possible that you will observe a large bump in your score once the issue is resolved, typically within 30 days.
Pay Your Bills on Time (And More Frequently)
It sounds boring, but in many cases, your payment history has the greatest overall effect on your credit score. Therefore, it’s very important to make payments on time, in full whenever possible. If you’re having trouble keeping track on your own, you can consider setting up autopay options for at least the minimum due, or creating reminders and alerts through your online accounts or calendars. If you’re able to pay your bills more frequently than once a month - or at the end of a billing cycle - that will not only keep your credit balance low, but it’s also a great way to reduce your credit utilization.
Improve Your Credit Utilization
In addition to paying your bills on time and more often, there are other ways to reduce your credit utilization, thereby improving your credit score. Raising your credit limit on an existing account, for instance, will increase the amount of credit available to you, and also decrease your credit utilization ratio. This is especially a good idea if your income has increased since you last applied for a credit card. Be strategic and use available knowledge to your advantage. For example, if you contact your bank or credit card company to find out when they send your information to reporting agencies, you can time any payments to occur just before they report.
Keep Balances Low
Missing a payment is a surefire way to lower your credit score, and it often takes a while for that black mark to fade from your report. Ensure that doesn’t happen to you by keeping balances low whenever possible. A common practice is to keep the balance at or below 10 percent on each line of credit, or less than 30% of your available credit overall. That on its own could be enough to improve your credit score. Conversely, a balance close to - or over - the limit will reduce your credit score significantly. Lenders may see you as a greater risk if you are using a lot of your available credit, even if you pay your balance in full by the due date.
Pay Down Your Debt, But Keep Old Credit Accounts Open
It may seem like a good idea to close a credit card that you’re not using anymore, but it actually can hurt your credit score quite a bit. This is because you lose that card’s available credit when you close it, and this can affect your credit utilization rate, and negatively impact your credit score as a result. The average age of all your accounts is also a factor in your credit score, so the best course of action is to use your oldest credit cards every few months. Putting a small, recurring bill on the card is an easy way to keep it active. Credit cards can stay open indefinitely, so keeping them open shows you’re capable of managing credit wisely.
Limit New Credit Applications
If you do need to apply for new credit, do it when you actually need it. Every time you apply, lenders will run what is known as a “hard inquiry” on your credit reports, and each one of these will knock some points off your score. If you rack up multiple inquiries, this can have a compounding negative effect. One strategy you can take is to cluster the applications within a few days or a week, as credit bureaus are more likely to combine these inquiries as a single inquiry for your score, and not treat them as an attempt to open several new lines of credit. This is beneficial when shopping around for a credit card, car loan or mortgage.
Improve Your Credit Mix
A mix of credit products - such as a credit card, a car loan, and a line of credit - may improve your credit score. Agencies will prefer to see consumers that have both installment and revolving credit options in their portfolio. Your credit mix is likely to improve naturally over time as your financial needs become more sophisticated, but maintaining this variety can be a factor in turning a good credit score into a great one.
If you’re able to leverage these strategies, you should see an improvement in your credit score within 30 to 45 days. Good luck!
