What affects your credit score might surprise you. For example, opening a new credit card can boost your credit score as long as you use it responsibly. On the other end of the credit spectrum, having a high balance on your new credit card can quickly lower your credit score.
The Federal Reserve’s G.19 consumer credit report shows that Americans increased their revolving debt, considered an estimate of credit card balances, to $1.126 trillion in June 2022, an increase of 16 % year over year. In May, revolving debt grew at an annual rate of 7.8%.
Coupled with an annualized inflation rate that hit 8.5% in July, many are wondering what happened to their once stellar credit ratings. At times like this, getting your highest score possible is key. A great credit rating gives you options to help you save money while getting out of debt.
What has the biggest impact on your credit score?
FICO scores are used by 90% of lenders, so I’m focusing on that credit score here. Five factors affect your FICO score, with payment history having the biggest impact.
Here are the factors that make up your FICO score and the weight assigned to them by the score algorithm:
- Payment history: 35%.
- Amounts due: 30%.
- Length of credit history: 15%.
- New credit: 10%.
- Loan composition: 10%.
Here are the FICO credit score ranges:
- Exceptional: 800-850.
- Very good: 740-799.
- Good: 670-739.
- Fair: 580-669.
- Poor: 300-579.
A high FICO score, which is at least 760, can get you the lowest interest rates on credit cards, mortgages, and personal loans. So let’s see what affects your credit score.
What lowers your credit score
Credit isn’t intuitive, and that’s one of the reasons it’s hard to understand what’s affecting your score. For example, most believe closing a credit card shows restraint and should boost your score. As you will see below, this is not the case.
- High use of credit. The reason credit card debt can lower your score is that it often results in high balances. You have a credit utilization ratio, which is the amount of credit you’ve used compared to the amount you have.
- Apply for multiple credit cards. Each time you apply for a credit card, it counts as a firm credit application. This can lower your score by up to five points. It’s for each application. Issuers view this type of frantic credit behavior as a sign of financial distress. You may be looking for sign-up bonuses, but it still lowers your score and it’s not a pretty sight.
- Sloppy bill paying habits. Now you know how important it is to pay your bills on time. Do whatever it takes to make timely payments. Set up reminders via email or SMS. Use money management tools that help you track expenses and payment due dates.
- Random closing of credit cards. Before closing a credit card, consider the impact on your score. You lose the available credit you had with that card, which may increase your usage rate. Keep your cards active unless you have a compelling reason to close them.
What raises your credit score
Of course, doing the opposite of what lowers your score is a good tactic. But there are also some sneaky strategies you can use to quickly increase your score.
- Increase your credit limit. A credit limit increase increases your available credit, which may reduce your credit utilization rate. The lower your ratio, the more it increases your credit score. Disclaimer: Do not attempt to ask your issuer for a higher limit unless you have an excellent payment history. Never draw attention to yourself unless you can stand up to the scrutiny.
- Make two payments per month. Call your issuer and find out when they report your payment history to the credit bureaus. To lower your usage rate, make an additional payment before the issuer reports your balance.
- Pay more than the minimum payment. When you’re in debt, it’s hard to think about paying more than you need. But if your score (and your cash flow) is low, reduce the balance by increasing your monthly payment, even if only a little. As your balance decreases, your score should increase.
- Get a new credit card. You can increase your score by getting a new card. The new credit limit increases your available credit, which lowers your utilization rate. Your goal with this card is to maintain a utilization rate below 10%. You opt for the newly available credit to improve your score. It’s not for shopping!
4 ways to get rid of debt
Once you have a higher credit score, you’ll have a whole new set of debt reduction options that can save you money. Think of it as a just reward for the hard work you’ve done to improve your score.
- Balance transfer credit card. With a very good score, you can transfer your credit card debt to a balance transfer card. These cards offer an introductory annual rate of 0% for a period generally between 12 and 20 months. You can pay off your balance during the introductory period without paying interest. Note that these cards usually have transfer fees, which vary from 3% to 5%.
- debt consolidation loan. If your score isn’t high enough for a balance transfer credit card, consider credit card debt consolidation. It’s a personal loan, and you can get a fixed interest rate that’s probably lower than your credit card rates.
- Loan between individuals. This type of lending, also called P2P lending, differs from borrowing from a traditional institution like a bank. Instead, P2P lenders offer a platform where you can borrow money from a person or business that invests in loans. As with traditional lenders, the better your credit rating, the better the interest rate you will receive.
What not to do to get out of debt
Don’t reach for your 401(k) with the naïve idea that you’ll pay it off quickly. This is even more important if your employer matches your contributions up to a certain point. Some of these plans won’t allow you to continue making contributions and get the employer match if you tap into the 401(k). But that’s just one problem with this strategy.
Do you know what happens if you don’t repay your loan within five years? You will have to pay penalties and fees. And if you lose your job, which is a possibility in a fragile economy, your 401(k) must be paid off by tax day the following year.
Don’t destroy the future for relief in the present. Your best bet for getting out of debt is to choose a good strategy and stick to it.