Why and How You Should Improve Your Credit Score

You hear about credit scores everywhere - television, radio, banks, car dealerships – you name it. People say you need to “build your credit” by opening a credit card and you may wonder what that means. Most people know that a credit score is a number that banks look at when approving you for a mortgage or loan. The higher your score, the more responsible you seem with your money to financial institutions. With all the focus these days on credit scores, you may wonder how it’s calculated and why it matters. Town and Country Bank and Peoples Prosperity Bank want to demystify the credit score system and show you how you can improve your score.

What is credit?

The reason people suggest you start building your credit at a young age is because, without debt, you have no credit history. You could work hard and always pay in cash, but when it comes time to borrow money for a house or a car, you won’t have a solid credit score. Banks want to see a history of timely repayment on small loans before they approve you for a mortgage or car loan.

Debt can come in many forms when you are first starting out. If you have a utility bill that you pay at the end of each month, that counts as credit. By paying the utility bill on time each month, you are showing that you can pay for a service that was advanced to you. A credit card is another way to start building credit. The same premise applies—you borrow money to make purchases throughout the month and earn good credit when you pay your credit card bill on time.

There are two main types of credit that affect your credit score:

Installment credit is a fixed loan amount with a fixed term. The money is advanced to the borrower and then repaid in monthly installments until the loan is paid off. Student loans, personal loans, and mortgages are common types of installment credit.

Revolving credit has no fixed term. Borrowers are approved for a maximum credit limit and they can spend and repay for as long as they wish. Revolving credit requires monthly payments but the loan amount is up to the borrower's discretion. Credit cards are the most common example of revolving credit.

What is a credit score and why is it important?

Different calculations of creditworthiness have been around since banks started making loans. In 1989, the Fair Isaac Corporation (FICO) created FICO Scores in order to create an industry standard for scoring creditworthiness. In the US, three national credit bureaus calculate consumers' credit scores. Experian, Equifax, and TransUnion use the same basic model for calculation but individual scores can vary slightly by the credit bureau.

Banks and credit unions use your credit score to approve or deny loans and accounts. If you are approved for a loan, the interest rate offered is determined by your credit score. The best credit scores get the lowest interest rates. Over a 30-year mortgage loan, a lower interest rate of just a couple of points can equate to tens of thousands of dollars saved! If you have plans to borrow money for a house or car, raising your credit score can save you significant money on interest in the future.

How is my score calculated?

Your credit score is composed of five different factors.

Credit History

Your credit history, or how long you’ve been using credit and paying bills, makes up 15 percent of your credit score.

Payment History

Thirty-five percent of your score comes from your payment history. Good payment history means you pay your bills on time and in full amounts.

Credit Mix

Banks want to see that you can handle different types of debt. For this reason, 10 percent of your credit score is based on your mix of revolving and installment debt.

Credit Inquiries

Always applying for the latest and greatest credit card can actually hurt your credit score. Too many new accounts and hard inquiries into your credit are seen as risk factors for most financial institutions. 10 percent of your credit score is determined by recent credit inquiries.

Credit Utilization Ratio

If you are maxed out on your credit cards, banks assume you are living beyond your means. Credit utilization is calculated by examining how much available credit you have compared to how much you are borrowing. If you have two credit cards and each one has a $6,000 limit, then your available credit is $12,000. If you have balances on those credit cards equaling $4,000, then you are currently using 33 percent of your available credit. For the best score in this area, you should keep your credit utilization rate below 30 percent.

What is an ideal credit score?

Now that you know how your FICO credit score is calculated, you can see where your numbers fall and what you should aim for. Credit scores are typically grouped into the following categories:

• Excellent: 720-850
• Good: 690-719
• Fair: 630-689
• Poor: 300-629

Many credit cards and websites allow you to see your credit score for free. Once a year you should pull your complete credit report and review it. Always access your free report from the Federal Trade Commission. Through the FTC, you can pull your report from each of the three national credit bureaus and compare the scores. It’s not unheard of for credit reports to contain errors. By checking your credit report each year, you can check for errors such as unauthorized account openings and credit inquiries.

How do I increase my score?

It’s never a bad idea to work on raising your credit score. The fastest way to increase your credit score is to lower your credit utilization ratio. Start paying off your debt now in order to lower your credit utilization ratio. Getting your utilization ratio below 30 percent will pop your credit score up in the right direction.

If you haven’t opened a new credit card in a while, you might consider it as a way to raise your credit score. Opening a new credit card will increase your available credit, which will help lower your overall credit utilization ratio. In the earlier example, the consumer owed $4,000 on his $12,000 available credit. If he is approved for a third credit card with a $4,000 credit limit, he is suddenly using $4,000 out of an available $16,000. This brings his credit utilization ratio down to 25 percent and should raise his credit score. Opening a new credit card is only going to improve your credit score if you use it wisely! Don’t use your new card as an excuse to accrue more debt and be sure to continue making your monthly payments on time.

Let your credit work for you.

Having a good credit score will save you money on interest payments down the road. Town and Country Bank and Peoples Prosperity Bank is dedicated to helping our customers enjoy healthy financial futures. Banking shouldn’t be overbearing or create anxiety. Our friendly and knowledgeable employees are happy to help answer any questions you have about credit scores or the loan approval process. Don’t hesitate to contact us or visit one of our 12 conveniently located branches today!