We’ve all heard of ways to “boost” your credit score, but why is it important in the first place? Because it affects your ability to borrow money and impacts the interest rate you pay.
Why is building your credit score important?
- Qualifying for a mortgage to buy a house
- Obtaining a credit card
- Obtaining a car loan
- Renting an apartment
- Starting a business
On the one hand our general principle is to avoid debt, be debt-free, and have healthy investment account balances by retirement. On the other hand, we realize there will come a time when you must borrow money, most commonly for a home purchase.
Let’s look at an example of someone with a good credit score of 800 versus someone with a 650-credit score and see how it affects the interest rate they are charged on a mortgage. Let’s assume current interest rates, a 20% down payment, and a home price of $412,000 (the median price in 2023).
Based on a 30-year mortgage, source–Google’s Average Mortgage Rates
Results
The borrower with a 650-credit score pays an extra $249/month which results in an additional $89,520 in total interest for the exact same house! The borrower with a credit score less than 620 couldn’t qualify for a conventional home loan at all! Your credit score matters.
So, how do you improve your credit score? Your score (350-850) is based on several factors: credit history, utilization percentage of your available credit, total debt owed, types of credit, number of accounts, on time payments, etc. Grading positively in each of these areas will result in a high credit score (750+). Ultimately, there is no secret “hack” to magically fix your score. There is, however, a real, long-term solution: Good behavior + Consistency + Time.
Use and pay, use and pay, and let time do the work. Continuously use your credit card and pay it off each month. The same goes for other debts, in that making payments on time can account for roughly 35% of your credit score. Another important metric is credit utilization. Try your best to keep this number below 30%.
Best practices to improve your credit score:
- Make sure your credit report is accurate. Reviewing your credit report may help catch signs of identity theft. While studying for my CFP exam, I learned that roughly 50% of credit reports are inaccurate. Therefore, it’s a good idea to review yours on occasion. You can view your credit report free once a year at https://www.annualcreditreport.com. My report said I opened my first credit card when I was nine years old (not true!).
- Build your credit as early as you can. Open a credit card at a young age, but ONLY if you’re NOT going to carry a balance. This starts building your credit history, which indicates to lenders you are a trustworthy borrower. Helping your young son or daughter open a card is beneficial for their long-term credit score, but once again, only if you teach them not to carry a balance. Otherwise, it could significantly hurt their future borrowing prospects. It does not help your credit score to carry a balance, it hurts it!
- Pay off debt on time & keep balances low. Good credit comes from low utilization (below 30%) and on-time payments. A low utilization ratio tells lenders you are not maxing out your credit cards and are a responsible user of credit. If you currently have bad credit, that’s okay. Focus on paying down your balances and once you no longer carry a balance continue paying your cards off each month and let time work its magic to heal your score.
- Request a higher credit limit. This helps decrease your utilization rate which will help boost your credit score. If you are in good standing with your credit card company, you may be eligible to raise your available credit limit. This is a simple, short-term solution.
- Limit your credit applications. Certain credit applications may trigger a “hard pull” of your credit. Hard pulls negatively impact your credit score for about a year and can remain on your credit report for about two years. You want to avoid multiple hard pulls within a short period of time.
Your credit score is your financial reputation. Build a good one!
Andreas Shick
