What affects your credit score might come as a surprise to you. For instance, opening a new credit card can increase your credit score as long as you use it responsibly. At the other end of the credit spectrum, carrying a high balance on your new credit card can lower your credit score in a hurry.
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, which is a 16% increase year over year. In May, revolving debt increased at a yearly rate of 7.8%.
Coupled with an annualized inflation rate that reached 8.5% in July, many are wondering what happened to their once-stellar credit scores. In times like this, it’s essential to get your score as high as possible. An excellent credit score gives you options that 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. There are five factors that affect your FICO score, with payment history having the largest impact.
Here are the factors that make up your FICO score and the weight they’re given by the score’s algorithm:
- Payment history: 35%.
- Amounts owed: 30%.
- Length of credit history: 15%.
- New credit: 10%.
- Credit mix: 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 a 760, can get you the lowest interest rates on credit cards, mortgages and personal loans. So let’s take a look at what affects your credit score.
What Lowers Your Credit Score
Credit isn’t intuitive, and that’s one of the reasons it’s difficult to get a grasp on what impacts your score. For instance, most believe that closing a credit card shows restraint and that it should increase your score. As you’ll see below, that’s not the case.
- High credit utilization. The reason credit card debt can lower your score is because it often translates into high balances. You have a credit utilization ratio, which is the amount of credit you’ve used compared with the amount you have available.
- Applying for multiple credit cards. Every time you apply for a credit card, it counts as a hard credit inquiry. This can drop your score by up to five points. That’s for each application. Issuers see this type of frantic credit behavior as a sign of financial distress. You might be chasing sign-up bonuses, but it still lowers your score and it’s not a good look.
- Sloppy bill-paying habits. You now know how important it is to pay your bills on time. Do whatever it takes to make timely payments. Set up email or text reminders. Use money management tools that help you track expenses and payment due dates.
- Randomly closing credit cards. Before you close a credit card, consider the impact on your score. You lose the available credit you had with that card, and that can increase your utilization ratio. Keep your cards active unless you have an overwhelming reason to close them.
What Boosts Your Credit Score
Sure, doing the opposite of what lowers your score is a good tactic. But there are also some sneaky strategies you can use to increase your score in a hurry.
- Increase your credit limit. A credit limit raise increases your available credit, which can lower your credit utilization ratio. The lower your ratio, the more it boosts your credit score. Warning: Don’t try asking your issuer for a higher limit unless you have an excellent payment history. Never call attention to yourself unless you can withstand the scrutiny.
- Make two payments in a month. Call your issuer and find out when it reports your payment history to the credit bureaus. To lower your utilization ratio, make an extra payment before the issuer reports your balance.
- Pay more than the minimum payment. When you’re in debt, it’s difficult to think about paying more than what is necessary. But if your score (and cash flow) is low, chip away at the balance by increasing your monthly payment even if just a bit. As your balance goes down, 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 ratio. Your goal with this card is to keep a utilization ratio under 10%. You’re going for the newly available credit to improve your score. It’s not for a shopping spree!
4 Ways to Get Rid of Debt
Once you have a higher credit score, you’ll have a new array of debt-reduction options that can save you money. Think of it as a just reward for the hard work you did 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 a 0% introductory annual percentage rate for a period that’s usually between 12 and 20 months. You get to pay off your balance during the intro period without paying interest. Note that these cards usually have a transfer fee, which ranges from 3% to 5%.
- Debt consolidation loan. If your score isn’t quite high enough for a balance transfer credit card, consider credit card debt consolidation. This is a personal loan, and you can get a fixed interest rate that’s probably lower than the rates on your credit cards.
- Peer-to-peer lending. 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 a company that invests in loans. As with traditional lenders, the better your credit score, the better the interest rate you’ll receive.
What Not to Do to Get Out of Debt
Don’t reach into your 401(k) with the naïve notion that you’ll pay it back quickly. This is even more important if your employer matches your contributions up to a point. Some of these plans won’t let you continue to make contributions and get the employer match if you dip into the 401(k). But that’s only one problem with this strategy.
You know what happens if you don’t pay back your loan within five years? You’ll have to pay penalties and fees. And if you lose your job, which is a possibility in a shaky economy, your 401(k) has to be repaid by Tax Day of the following year.
Don’t destroy the future for relief in the present. Your best bet to get out of debt is to pick a good strategy and stick to it.