How to Build a Great Credit Score: Breaking Down the Steps
We get it: understanding your credit score can be tough. If you’ve recently checked your credit score and been surprised to find it lower than you expected it would be, you’re far from alone. Your credit score is influenced by a combination of numerous factors, and even seemingly small actions can make a big difference in terms of where your score ends up.
In that light, our friends from The Credit Counselling Society have shared some valuable insights on what determines your credit score and how you can take action to improve it. We’ll let them take it away…
While people will often look to their budget to find areas to save money, they rarely consider how improving their credit score can impact their savings too. The fact is that a poor credit score means being perceived as a higher risk and being charged a higher interest rate for a loan or paying higher premiums for insurance coverage. That can cost thousands of extra dollars over time. Paying even an additional 1% on a mortgage can mean tens of thousands of dollars in extra interest payments over the life of that mortgage. That is money that could be used to grow dreams.
When looking at how your credit score is calculated there are 5 main variables to consider. By understanding how small actions can positively impact each of these areas, you can begin to take steps to dramatically improve your credit score. This will tell lenders and others that you are a good and safe bet for loans, for insurance, or even for renting an apartment.
1. Payment History (35%)
The largest factor in creating a good credit score is to pay your lenders on time every time. Not only will this save you from increased interest rates and late fees, but it demonstrates to your creditors, current and future, that you know how to manage your money and credit properly. There are two easy steps to ensure that this happens:
1) Review your statement carefully to confirm what the minimum payment is and when it is due. If you’re even a penny short or a day tardy, the payment shows as late, the interest clock starts ticking, and your credit score can be impacted.
2) Ensure that your creditor receives the payment by the due date. If you’re paying from one bank to another, it could take 3 business days for the funds to transfer. If this is the case, you need to pay early to avoid possible late penalties and damaging your credit score.
2. Amount Owed (30%)
How much credit you use can also play a big role in the credit score calculation. The rule of thumb is to never exceed 60% of any credit limit. For example, if you have a line of credit with a $10,000 dollar limit, it is important to never use more the $6,000 of that available credit. Exceeding the 60% limit will bring your credit score down because it suggests the credit is not being used as a tool for convenience, but instead as a money crutch to scrape by with. When you must make a purchase that would take you over the 60% limit, a good tip is to prepay your credit card or line of credit by that extra amount, so you stay under the limit.
3. Length of Credit History (15%)
The longer you have had a well-treated credit product on your credit report, the better the story it will tell existing and future creditors. The best information comes from credit accounts that have been open for 6 years or longer. As a result, it is important not to be closing accounts too often.
4. Types of Credit (10%)
Revolving types of credit, like credit cards or lines of credit, are better tools to build and repair a credit score than other types of credit like mortgages or car loans. They provide more information in terms of changes in utilization, payment amounts, and frequency used. They also actively report even when not used for several months. Loans will help build credit, but they are 100% utilized when taken out, and once paid off, they no longer report active information.
5. New Credit (10%)
The final piece of the credit score pie refers to not applying for new credit too often. Every time a lender looks at your credit history, the credit score drops a little. While it is a good idea to make lenders compete for your business to ensure a good interest rate, applying at more then a few can send a credit score plummeting and interest rates soaring.
To summarize, building and maintaining a great credit score comes down to 5 key ideas:
1) Pay on time all the time
2) Do not use too much credit
3) Do not close positively reporting credit accounts that have been open for a long time
4) Revolving credit like credit cards builds a better score faster than other types of loans
5) Do not apply for new credit too often
An important sixth key thing to remember is that it’s ok to ask for help. A bank, credit union, or non-profit credit counselling agency can help explain how to establish, maintain, or fix your credit score. Asking for help can be hard, but it can also end up saving you thousands of dollars.
The Credit Counselling Society is an accredited non-profit charity that helps Canadians solve their money problems. They do this by providing free credit counselling, low-cost debt solutions, and education to help you manage your money better. Learn more at nomoredebts.org or call 1-888-527-8999.
