When evaluating loan applicants, a private lenders’ goal is to determine if you are creditworthy and able to make your scheduled payments.
They analyze your income, employment history, and pre-existing debt to ensure you have the financial wherewithal to repay them.
Another major factor they check is your credit score, which is a single number that paints a picture of your current financial situation and borrowing history.
Improving your credit score can result in better loan terms and lower financing costs, ultimately saving you huge sums of money over time.
How Credit Scores Affect Loans
In general, the higher the credit score, the lower the interest rate.
There are numerous credit bureaus in The United States with FICO being the largest and most widely used brand of credit score.
Credit scores range from 300 to 850.
According to FICO, these are the interest rates you would face for a 30-year mortgage on a $300,000 dollar property, depending on your credit score:
Notice the difference in rates between a score in the low 600s and one in the high 700s is about 1.6%, which would lead to a $268 dollar difference in monthly mortgage payments.
Across 30 years, this would amount to savings of almost $100,000 dollars, or one-third of what you paid for the property!
Even a modest increase in your credit score from 620 to 640 would save you $34,200 dollars in interest over the life of the 30 year mortgage.
Credit Score Breakdown by Weighted Percentage
Before coming up with a strategy to improve your credit score, you first need to understand how it’s calculated.
Your FICO credit score uses a formula to weigh different factors which are combined together to determine your creditworthiness.
It’s broken down in the following way:
Payment History – 35%
Your payment track record is the biggest indicator of your ability to pay down a balance. Making late payments or missing them completely will significantly decrease your score.
Amounts Owed – 30%
The amount of debt you carry is another important factor as it increases your default risk. If you have too much debt, lenders will be skeptical of your ability to manage your financial commitments.
Length of Credit History – 15%
The age of your financial accounts is a measure of how proven and consistent your borrowing record is. The more data available, the more accurate a picture lenders will have of your reputation.
Credit Mix – 10%
FICO considers how you handle all types of loans, including:
- credit cards
- mortgage loans
- auto loans
- and student loans
New Credit – 10%
The need for quick cash is often a sign of financial trouble, so opening up too many new accounts at once will be viewed negatively by lenders.
10 Ways to Improve Your Credit Score
Earn extra income and start budgeting
In the long run, achieving a high credit score comes down to making timely payments and reducing your debt.
If your unable to make your payments, re-evaluate your financial situation and consider making extra income through freelance jobs or cutting personal expenses.
Set up auto payments
Setup autopay for all possible accounts. If possible, pay the full balance or at least the minimum amount so you never miss a payment and can steadily build your creditworthiness.
Use balance transfer promos to save on interest
If you get stuck paying down an increasing balance due to high interest, apply for a credit card with a 0% APR promotional rate for 12 months and transfer over your balance.
This will give you at least 12 months to save without incurring interest charges.
Automate minimum payments on your new card to retain the promotional rate and be sure to pay the full balance when the time comes.
Ask for a credit limit increase
Regarding the amount of debt, the actual measure used is credit utilization, which is the ratio of what you owe to how much credit you have access to across all accounts.
Lenders want to see your balance is less than 30% of your credit limit, a quick way to reach this is by requesting an limit increase from your current card issuers.
Never close a credit card
Canceling a credit card will eliminate a part of your credit history and reduce the average age of your accounts, in effect negatively impacting your score.
If you have a card with an annual fee you want to close, ask your issuer for a product change to a card with no fee so your account history remains intact.
Factor in other information
If you have a short credit history, you can find a service that formulates your score by incorporating other financial information such as payments on rent, cell phone service, and utilities.
Such programs include Experian Boost, UltraFICO, and Rental Kharma.
Avoid too many new accounts
Every time you apply for a new card or loan, there will be a hard inquiry, which is a request for your full credit report.
Too many of these requests at once are a signal of risk to lenders and will lower your credit score.
Check your credit report for errors
Examine your credit reports from Equifax, Experian or TransUnion (which can be obtained for free on AnnualCreditReport.com).
These reports will breakdown your credit history and help you understand where your current score came from.
Cross reference the credit report with your financial records and dispute any errors effecting your score.
Monitor your credit score
Most credit card accounts offer a snapshot of your credit score and some key data points. Keep track of your progress to catch mistakes before your score is negatively impacted.
Remember, every American is entitled to one free annual credit report.
Explore other financing options
If you have trouble with credit cards, consider using other types of loans to build your credit.
These include auto loans, bank loans and retail credit programs. Paying these loans will put you on a path to a higher credit score.
Having a great credit score will save you money and also increase you borrowing power.
You should make sure to make all your payments on time and keep your debt load manageable.
A high credit score is fundamental to your financial health and freedom.