Improving Your Credit

How to Improve Your Credit Rating

    It is important to have a stable credit rating in order to obtain a mortgage. In this article we will discuss the different factors creditors take into account when determing whether or not they are willing to lend to you and helpful tips that can help improve your credit score. Your credit score is determined by companies called credit bureaus. A "credit bureau" is a company where lenders report an individuals debts and payment history. The Credit Bureaus use this information to determine what they call your FICO score. There are several factors that are taken into account when determining your FICO score including payment history, amounts owed, length of credit history, credit utilization, new credit, and credit mix.

Payment History & Amounts Owed

Payment history and amounts owed are the two biggest factors when a lender is looking at a credit report. This is because they want to make sure you pay your bills on time and that you will be able to afford the new debt being issued. To ensure that your score continues to move upward rather than downward, make sure to pay all bills on time and do not take out more debt than you can handle. 

Credit Mix

 To take things further, Lenders want to know what type of debt you have. Different types of debt include secured debt, unsecured debt, revolving debt. They like to see a mix of these on your report because it lets them know you are responsible when utilizing your credit and paying your bills. 

Secured debt: Examples of secured debt are Automotive loans and Mortgages. Typically these loans have lower interest because the creditor is promised collateral in case of payment default. They help contribute to your payment history and mix of credit which can boost your credit as long as you are making payments  on time. 

Revolving Debt: Revolving debt is an agreement that permits an account holder to borrow repeatedly up to a certain dollar amount or limit. Examples of revolving debt are credit cards and lines of credit. If used wisely, these can positively affect your credit by providing payment history and contributing to the credit mix. However it is very important to take into account credit utilization when using revolving debt. Credit utilization is the amount of available credit you have already spent. In order to keep your score moving in the right direction your revolving credit utilization needs to be below 20%. That means if your credit card has a $1000 limit it is important to have no more than $200 utilized at the end of a billing cycle. Typicallly, lenders will report to the credit bureaus at the end of a billing cycle so it is important to have your revolving debt paid down below 20% utilization before they report. Another tip is to never close down a credit card account or a line of credit. This will remove credit history from your report and it will negatively impact your score. Instead use the account to buy one thing a month and make sure that you pay the card off in full at the end of the billing cycle. This will increase your available credit and help you keep your utilization rate down. Revolving debt can be very dangerous to your FICO score unless used properly. As long as you keep your utilization below 20% after you make your payment you will be successful in raising your score.

Unsecured debt: are loans that do not require collateral in case of payment default. Examples of these would be personal loans. Personal loans can be both positive and negative to your credit rating. If used correctly they can help show payment history and they contribute to your mix of credit. Typically personal loans have higher interest than secured loans and lower interest than revolving debt. Many people use Consolidation Loans (a form of personal loan) to payoff revolving debt because they are not charged as much interest. 

Using Consolidation loans to Payoff Revolving Debt

You can use personal loans to payoff revolving credit which in turn can raise your credit score.This is because personal loans do not affect your credit utilization rate. It is important to remember that if you plan to consolidate revolving debt with a personal loan that you fix spending habits. Do not payoff a credit card with a consolidation loan and then go back to maxing out your credit card. Otherwise you will owe for your credit card and your personal loan which will put you further in debt. Instead use the consolidation loan as a tool to make your debt easier to pay off. If that means cutting up your credit card after paying it off by all means do so but do not close the account. If you do not use the card for a long period of time the creditor will usually close the card out for you which does not impact your score negatively. 

New Credit

While it is okay to get new loans, it is important to limit credit inquiries. This is because creditors do not want to see you pulling out a bunch of new debt right before they lend to you. The safe rule is to have no more than 4 credit inquiries per year. If you are applying for a mortgage lenders tend to send people away if they  have to many recent credit inquiries. They want to ensure that you will be paying them back and that you will not have a lot of new payments to account for. 

For more information, Please click here to read an article about how FICO advises your to build a secure rating.