Want to Raise Your Credit Score? Here’s a Clever Way to Do It
How important is a credit score? It depends on the circumstances, but since it determines the interest rate on your mortgage, it can have a huge effect on how much you spend.
For example, if you borrow $200,000 to buy your home and have an excellent credit score of 740, Fox Business estimates that you’ll pay $344,778 over a 30-year term. However, if your credit score is poor at 639, you'll pay an additional $63,173 in interest over the life of the loan!
Is $63,000 important to you? If so, you’ll want boost your credit score. Here’s a smart strategy that helps you do it as quickly as possible.
How to Increase Your Credit Score
Your credit score is made up of five basic components, according to CreditCards.com. Here's a look at how much of your score is based on each one:
- Payment history: 35%
- Credit utilization: 30%
- Length of credit history: 15%
- New credit: 10%
- Credit mix: 10%
The first factor on the list is no surprise. Pay your bills on time and you'll get a better score … eventually. But the effects of past mistakes remain for years.
What about increasing the length of your credit history for each line of credit you have? All you can do about that is to wait.
You can avoid getting too many new credit cards at once, so your score doesn't drop.
You could take out a personal loan to make your "mix" look better, but that costs money and won't have a big impact.
So yes, there are some things you can do to eventually increase your credit score, but to do it faster and raise the score higher, the key is to reduce your credit utilization ratio.
What is a Credit Utilization Ratio?
Also called the credit utilization rate, this ratio represents how much of your available credit you actually use. To get the number, just divide what you owe on a card (or all of them) by the credit limit for that card (or the total for all of them).
For example, suppose you have two credit cards. You charge $3,000 on a card with a credit limit of $4,000, and $1,000 on your other card, which has a limit of $6,000. In that case, you have a ratio of 75% for the first card and 40% overall (you're using $4,000 of your $10,000 total available credit).
Both ratios affect your score. “Credit scores consider both your total balance-to-limit ratio, or utilization rate, and your balances as compared to the limits on individual accounts,” says redit information provider Experian.
Many experts suggest keeping your ratio no higher than 30% or so. However, the lower your ratio is, the better your score is likely to be, according to a study done by Credit Karma. This finding held true all the way to zero (but interestingly, not including zero -- apparently it's better to have something owed on those cards). The average credit score for people with a credit card ratio of 1% to 10% was 745, compared to just 543 for those with a credit card utilization rate of 100%. But even going from the 1% to 10% range to the 21% to 30% range dropped the average score by 35 points, to 710.
The bottom line is that for a higher credit score, you should get your credit utilization ratio as low as possible.
How to Lower Your Credit Utilization Ratio
There are two basic strategies for lowering your credit utilization ratio:
- Reduce what you owe
- Increase your available credit
You'll want to do both to get the best score. Let's start with number one; reducing what you owe on those cards. Here are some things to try, according to Credit Karma, BankRate.com and NerdWallet.com:
Pay Balances at the Right Time
Your credit utilization ratio is calculated using the balances you have at the time your credit card issuers report to credit bureaus. Call to see when that is, and adjust your payments accordingly.
For example, I just called the issuer of one of my Visa cards and was told they report information on the 2nd of each month. Since I typically pay off my balances toward the end of every month, I end up with a very low ratio, because by the 2nd I haven't had time to charge much on the card. If I paid around the 3rd of each month, however, they would be reporting my balances at their highest point in the month (the day before I pay), making my ratio higher.
Paying shortly before the information is reported is the best strategy. If figuring that out sounds like too much trouble (it might involve timing payments differently for different cards), try the next suggestion.
Pay Twice Monthly
If you don't want to bother with tracking when each card should be paid, you can pay twice monthly so your average balance is always lower on each card. Just set up automatic payments to make this easy.
Balance Your Card Use
If you charge $1,000 on a card with a $2,000 limit and charge nothing on three similar cards, your overall credit utilization ratio might be 12.5%, but it will be 50% for that one card, and that will hurt your score.
To avoid this, note the credit limit for each card and, when you reach 20% of the limit, put the card away and use another. If you're not good at tracking these things, see the next suggestion …
Set Up Alerts
Many credit card issuers let you set up email alerts related to your spending. If yours does, set it so you get an email when your balance reaches 20% of the card's credit limit. Once you get that email, you can start using another card or pay down the balance before charging more.
Spend Less on Your Cards
This is perhaps the most obvious way to lower your credit card balances. Make it a habit to spend less overall, or just move to using cash when you get past a certain threshold utilization ratio, like 20%.
Once you've taken some of the steps above, you can move on to the following tactics, which are potentially even more powerful. They're all about increasing your available credit.
Get More Credit Cards
Suppose your credit card limits total $10,000 and you owe $4,000. You have a credit utilization ratio of 40% -- which is not good. Your credit score will reflect that.
But without reducing your debt one penny, you can reduce your credit utilization ratio to 20% by simply getting another credit card with a $10,000 limit -- or several more that add up to that much.
Will having too many credit cards count against you? Not unless you get them all in a short period of time (some credit score compilers see that as an indicator of financial problems). Ethan Dornhelm, a scientist at Fair Isaac (the company that created the FICO scoring system), tells Bankrate.com that "simply having a large number of credit cards is not going to have a negative impact on your FICO score." The Bankrate.com article uses an example of one man who has 80 credit cards and still maintains a score between 795 and 819.
Don't Close Too Many Cards
You probably should close credit card accounts if the cards have annual fees, but otherwise it may make more sense to just put them away and not use them. Closing them reduces your available credit, and so automatically increases your credit utilization ratio.
If you don't trust yourself with that much available credit, you might want to leave the accounts open but cut up the cards, so you have the credit lines but can't use them easily. The only downside to this strategy is that after a year or two, the issuer may cancel your cards due to inactivity.
Ask Issuers to Raise Your Credit Limits
Perhaps the easiest way to expand the credit you have available, and so reduce that key ratio, is to get the limits on your existing cards increased.
The only catch is that when you request an increase, your issuer might do what's called a hard inquiry, which can knock a couple points off your credit score. Financial expert Emily Davidson suggests that you first ask your credit card issuer if requesting a credit limit increase will result in a hard inquiry, and also ask if you are likely to get the increase.
It's probably worth losing a few points if you can get a substantial credit line increase, since you may very well boost your score by many more points for your effort. On Kiplinger.com, reporter Stacy Rapacon says getting her credit utilization rate in better shape boosted her credit score by more than 50 points in less than six months.
Keep Your Cards Active
I once had a card canceled because I hadn't used it in two years. It was a card with a $10,000 limit and it was my oldest card. My credit score fell due to both the resulting higher credit utilization ratio and a shortening of my average credit history.
To keep this from happening, put each unused credit card in an envelope with the last date you used it written on the outside. When it gets close to a year, take the card out and use it for one of your regular purchases, then put it away again (and pay the balance in full, of course). I haven't had another card accidentally cancelled since I started using this system.
Remember, keeping those credit lines open keeps your total credit availability higher, and your credit utilization ratio lower, which is exactly what you need for a higher credit score.
Your Turn: Do you know your average credit utilization ratio? How will you try to reduce it in order to boost your credit score?