It’s Not About Paying in Full Every Month
It’s common knowledge that a high credit score is the key to low-interest loans and increased purchasing power. But what makes a credit score go up? Counter to conventional wisdom, people who keep their credit card balances near zero and always pay their bills on time might not have the highest possible credit score. Many factors are used to calculate the score beyond the main checks on timely paying of bills and having no maxed-out lines of credit. Some of the methods for helping a score go up are surprising.
The bulk of things you can do are the obvious: Pay your bills on time, keep your balances low. The mix is not nearly as important. But it is important to have at least one credit card or revolving account.
— Rod Griffin, director of public education, Experian
Not all credit types are the same, and credit scores may be calculated in different ways depending on the purpose. The best way to ensure a high score across the board is to have a well-rounded credit report.
Look through your credit report to see if you have any gaps that are easy to plug. While mortgages and car loans aren’t something that may — or should — be added simply for the sake of a credit score, different types of credit cards may be considered.
Having a credit card provides credit rating agencies a snapshot of how you spend money and choose to pay off your debts. Unlike installment loans, which offer no choice on how much to pay or when to make payments, the flexibility of credit cards is an important window into how you handle financial responsibility.
“The bulk of things you can do are the obvious,” said Rod Griffin, director of public education at the credit rating company Experian. “Pay your bills on time, keep your balances low. The mix is not nearly as important. But it is important to have at least one credit card or revolving account.”
“With a charge card,” Griffin said, “you have to pay the amount in full each month, but there’s still an insight into how much you choose to spend that an installment loan doesn’t provide.”
Responsible use of a credit or charge card is better for your credit score than not using revolving credit at all.
Three Credit Agencies, Three Different Scores
There is no official method for calculating a credit score. The Fair Isaac Company (FICO) score method is open to public scrutiny, but of the three major credit reporting agencies (Equifax, TransUnion and Experian), only Equifax uses the FICO calculation method. The other two companies use proprietary formulas. In addition, all companies that calculate a credit score use various formulas depending on the reason the score has been requested. The same company may return one score to a potential landlord and another to a potential mortgage lender. Your exact score is therefore less important than the general range into which it falls. Differences of 20 or 30 points matter less when the overall score is always near the top of the scale.
Keep Accounts Open
Intuitively, a large number of open accounts that aren’t being used seems like a bad thing for a credit score. However, credit history is a fairly important factor in credit scores.
Credit scoring formulas react negatively to sudden flurries of activity. This goes for closing accounts as well as opening them.
You should consider closing only those accounts that are not among the four oldest accounts on your report; those that charge an annual fee; those that are the same type as several other open accounts; or accounts that you don’t plan to use in the next year. Even with these truly “extra” accounts, close only one at a time, waiting 30 to 60 days between account closings, so that each month’s credit report registers and absorbs one account closure at a time.
Remember, it’s not the number of accounts you have open, but how you use them. Having several long-term, lightly used accounts with on-time payment history does not harm your credit score and might help it. Reasons to close accounts include avoidance of fees and the temptation to spend beyond your means.
Spread Out New Credit Requests
As your credit score increases, offers flood in for better loans and credit cards, and it can be tempting to convert all your higher-interest debt at once. A slow but steady conversion, however, may prevent a drop in your credit score.
Credit score formulas are created to catch any behavior that might make a new lender nervous. One of those behaviors is a sudden rush of newly opened accounts, since this signals a change that might represent a break from how that account holder behaved in the past. Even a conscientious bill payer with a long history of responsible credit use may be penalized for rushing into too many new, attractive offers at once.
By all means, take advantage of those low interest rates; you’ve earned them with your solid credit. But transfer balances one at a time and wait 30 to 60 days between opening new accounts. This avoids triggering the “new credit” component of the score, which may represent up to 10 percent of the total score.
Stability Is a Plus
Because credit scores are all about stability, having an ever-changing roster of addresses, phone numbers and employers can actually hamper your score.
For those who know they will continue to move frequently, a post office box can be a good idea for establishing stability with creditors. Use the box address whenever signing up for a new line of credit or opening a new bank account. If you opt for online payments and statements — which nearly every creditor and bank now offer — you’ll rarely even need to check the box. Some mailbox services also offer mail forwarding for a small fee.
Similarly, use a cell phone number instead of a home number on credit and bank applications. The reason is that cell phone numbers are portable from one location to another and even from carrier to carrier, while landlines require a new number each time you set up service in a new area code. Neither of these tricks creates a significant boost in your score, but having one phone number and address for seven to 10 years does reflect stability.
Bankruptcy Can Help
Many debt forgiveness firms and bankruptcy attorneys tout the rehabilitation your credit score gets from a successfully discharged Chapter 7 or Chapter 11 personal bankruptcy. This is true — but only gradually, and only after an initial drop.
“The purpose of bankruptcy is not to get rid of the debts you owe in order to get more debts as soon as possible,” said Experian’s Griffin. For that reason, credit scores become somewhat irrelevant in the wake of a bankruptcy.
Griffin added: “The number doesn’t matter outside the context of the credit report.” Because a credit report carries the bankruptcy notice for seven years, any credit score you carry will be tainted by that information. However, for consumers struggling with extremely low credit scores because of overwhelming debt ratios and an inability to pay back bills on time, bankruptcy is one solid path to slowly increasing that score.
But doesn’t the number go up for people with low credit scores?
“Typically, it will go from abysmal to very poor,” Griffin said. “You can get credit, but the question to ask is: What kind?”
The key to a solid score in the long run is not taking advantage of the loan offers that come flooding in immediately following a bankruptcy. Because federal law allows individuals to receive bankruptcy protection only once every seven years, some lenders see recently bankrupt consumers as targets for high-interest, high-fee loans that can’t be ducked for any reason. Staying out of revolving debt in the wake of a bankruptcy is the only surefire key to emerge at the other end with a chance for a significantly improved credit score.
Tips & Warnings
- Always read the fine print before paying any company to see your credit score. Many companies automatically enroll customers in a recurring fee-based program that may or may not be what the customer was looking for. A free credit report — with no credit score included — is available once a year.