A Guide to Understanding and Improving Your Credit Score

May 31, 2024

A lower credit score can be a significant hurdle in achieving your financial goals, from securing a mortgage, to getting favorable interest rates on loans, insurance and credit cards. A poor credit score could also keep you from being approved for an apartment rental. Understanding the common issues that lead to a lower credit score and knowing how to address them is crucial for financial health. The following is a helpful guide that explores the primary factors that can negatively impact your credit score along with actionable steps to improve it.

Common Problems Leading to a Lower Credit Score

1. Late or Missed Payments
Payment history is one of the most significant factors affecting your credit score, accounting for about 35% of your FICO score. Late or missed payments can severely damage your credit rating.

Avoid this situation by setting up automatic payments or reminders to ensure you never miss a due date. If you do miss a payment, try to make it as soon as possible, as longer delinquencies have a more severe impact.

2. High Credit Utilization Ratio
Your credit utilization ratio is the amount of credit you’re using compared to your credit limit. This component makes up about 30% of your credit score. A high ratio indicates that you might be overextended.

Aim to keep your credit utilization below 30%. Pay down existing balances and consider requesting a credit limit increase (without increasing your spending) to improve this ratio.

3. Too Many Hard Inquiries
Each time you apply for new credit, a hard inquiry is recorded on your credit report. Multiple hard inquiries within a short period can suggest that you are in financial trouble, which can lower your score.

Be strategic about applying for new credit. If you need to shop for rates, do so within a short period (usually 14-45 days) to minimize the impact on your score.

4. Defaulting on Loans
Defaulting on loans (meaning failing to make payments), such as credit cards, auto loans, or mortgages, can significantly damage your credit score. Defaults stay on your credit report for up to seven years.

Communicate with lenders if you’re struggling to make payments. Many lenders offer hardship programs or can help you work out a more manageable payment plan. Even if you can’t make a full payment, strive to at least make the minimum monthly payment if possible.

5. Errors on Your Credit Report
Errors on your credit report, such as incorrect account information or fraudulent activity, can negatively impact your credit score.

Regularly check your credit reports from the three major bureaus (Equifax, Experian, and TransUnion). If you find any errors, dispute them immediately with the credit bureau. However, be careful when trying to access your report. There are many services marketed to access your report but often come with a cost. Unreputable vendors may also try to get you to disclose confidential information or sell your information. Before paying for, or sharing any confidential information, ensure the vendor you are looking at is legitimate. Every consumer is entitled to a free credit report annually from each of the three credit bureaus. You can access all three at once or spread them out to monitor a different one throughout the year. You can learn more and get access at www.annualcreditreport.com.

Steps to Improve Your Credit Score

• Pay Bills on Time – Consistently paying your bills on time is the most effective way to improve your credit score. Set up automatic payments or use reminders to help you stay on track.
• Reduce Outstanding Debt – Focus on paying down high-interest debt first while making minimum payments on other debts. This approach, known as the debt avalanche method, can help you save on interest and reduce your debt more quickly.
• Increase Your Credit Limits – If you have a good payment history, consider asking your creditors for a credit limit increase. This can help lower your credit utilization ratio, provided you don’t increase your spending.
• Become an Authorized User – If you have a family member or friend with good credit, ask if you can become an authorized user on their credit card. This can help boost your credit score by adding their positive payment history to your credit report.
• Diversify Your Credit Mix – Having a variety of credit types (e.g., credit cards, installment loans, mortgages) can positively impact your credit score. However, only take on new credit if it makes sense for your financial situation.
• Keep Old Accounts Open – The length of your credit history contributes to your credit score. Closing old accounts can shorten your credit history and negatively impact your score. Keep old accounts open, especially those with positive payment histories.
• Regularly Monitor Your Credit Report – Stay proactive by regularly monitoring your credit report. Use www.annualcreditreport.com to check your credit score and report and address any inaccuracies promptly.

Improving a low credit score is a gradual process that requires consistent effort and good financial habits. By understanding the common issues that lead to a lower score and implementing the strategies outlined above, you can work towards achieving a healthier credit profile. Remember, a good credit score opens doors to better financial opportunities, so the effort to improve it is well worth it.

If you’d like to learn more about credit reports and managing your credit, we recommend visiting the resources available on the FTC website.