Your credit score is a magical thing. Sure, it’s just a number. But wait until you decide to make a major purchase like a car or home. Then your credit score turns into cash: Raising it just a couple of points can save a significant amount of money.
A credit score of 720 may get you an auto loan with an interest rate around 5%. A score of 620 could raise your interest to at least 13%.
Fortunately, there are some simple things you can do to give your credit score a boost before you apply for a loan.
The most common credit-scoring system was developed by the Fair Isaac Corp. and is known as a FICO score. It’s used by major credit bureaus to evaluate your credit history. The system considers factors like how many credit cards you have and how quickly you pay your bills, and assigns you a rating between 300 and 850. There are other scoring systems, including the VantageScore, which rates borrowers between 501 and 990.
Your credit score tells a lender how good you are at holding your end of the deal when you borrow money and predicts the chances of a 90-day default in the next 24 months. “The whole system exists on three words,” says Eddie Johansson, president of Credit Security Group, a firm that assists consumers with rapid re-scoring and FICO education. “Paid. As. Agreed.”
Two of the most important factors affecting your score are your payment history and whether you’ve had any collections.
The shorter your credit history, the greater the effect delinquent payments could have on your score. Missing a payment, even just one, could be bad news. It doesn’t matter how much the payment is, or what it’s for–anything from late cable-TV bills to outstanding parking tickets could adversely affect your rating. Johansson says missing just one payment can lower your credit score by as much as 100 points.
Similarly, if you ever have a late bill go into collections, it doesn’t matter how big it was or how quickly you paid the collection agency. The fact that the collection occurred at all is a major stain on your credit. You are now seen by FICO as a risky borrower and will remain that way for years.
The length of your credit history is important, so try to preserve it. If you need to close a card, close the most recent one you’ve opened. Or simply keep all your cards open and rotate them
so you’re only using one every month. As long as you don’t have high balances or missed payments on any of the cards, there is no credit score penalty for keeping multiple cards open.
One of the simplest ways to improve your credit score quickly is to time when you pay your credit card bills and when you go to apply for a loan.
The trick plays off the fact that credit card companies want to keep your score low so they can charge a higher interest rate. They can do this by calculating your credit score right before your bill is due–that’s the point when you probably have the most charges on the card and your debt-to-credit ratio is the highest. It makes you appear to be a riskier consumer, even if you do pay your bill off in full just a few days later.
To beat the system, Johansson suggests you pay off your credit card bills and then wait a full billing cycle before charging any more purchases on the card. That means your credit card company will report your debts to the credit agencies when you have a low balance. Then, right before you visit the loan office, put a small charge on the card–around 5% of your limit. FICO likes to see that you’re still using credit, but doing so responsibly.
If you don’t know what your current credit score is, you have a few options. First, avoid Web sites that advertise a free credit report. In most cases, you’ll end up having to pay in the end. The only place you can truly get a free credit report is at the government-sponsored site AnnualCreditReport.com. Keep in mind, though, that this free report only shows your credit history, not your FICO score. You can get your FICO score directly from Fair Isaac for around $30.
If it turns out you do have a low score, it’s worth spending time to raise it, even if that means you put off applying for a loan. Consider hiring a credit counselor to help you perform a “rapid re-score.” It might cost you $100 or more, but that’s small change compared to what a lender might demand in higher interest rates.
For better or worse, much of your life is judged according to whether you’re a reliable borrower. Your credit score plays a role in almost every major purchase you make. It’s wise to constantly maintain good credit–and even wiser to spruce it up before judgment day.