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7 Steps to Improve Your Credit Score

Whether you think we’re out of the recession or not (I would bet “no” based on the responses last week [3]), it’s always important to play a little personal finance defense. Today, the topic is on credit scores and how to improve your score by taking a few small steps.

These aren’t steps you can use to boost your score 100 points overnight… those don’t exist. These are simply smart moves you can make, over and over again, that will ensure your score will be as accurate and as high as possible. And if anyone says they can boost your score 100 overnight, chances are it’s a scam (unless you have some egregious errors on your report!).

Review Your Credit Report

The easiest way to improve your score is to ensure your credit score is accurately calculated. Each year you can request your credit report for free via AnnualCreditReport.com [4], a website setup by the government to help you get your reports. By reviewing your report, you can get anything incorrect, positive or negative, removed from your report. Since your report and score affect more than your ability to get loans, it’s always important to keep it correct.

Dispute “Errors & Inaccuracies”

This is a secret tactic of many “credit card repair” services – they dispute everything negative on your account. The credit report industry works on voluntary reporting by creditors. Credit card companies don’t always report every late payment because it’s simply too much work for very little return. They usually only report it if it’s 30 or 60 days late.

What this also means is that sometimes they won’t respond whenever the bureau requests more information. If you dispute an error, the bureau has to go to the creditor to have them confirm the information. Sometimes they confirm it, sometimes they don’t. Sometimes they no longer exist. If they can’t confirm it, it must be removed from your report.

Focus on Making Timely Payments

35% of your credit score depends on your payment history, the largest factor of the five listed by Fair Isaac. Creditors don’t care if you have debt as long as you’re making timely payments! That’s why it’s so important to ensure that you make your payments early or on-time.

So many times we miss making an on-time payment for stupid reasons. We forget to put the check in the mail. We forget to hit confirm on the billpay screen. We forget because we’re on vacation. Set up a system so that you will never miss a payment because you forgot. I setup electronic billing so I am sent an email each month reminding me to check my statement. I also set a reminder in my phone to remind me when my bill is usually do, since the date itself drifts between a few days. Finally, once a month, when I do a financial check in [5], I poke my head into each of my accounts when I review the transactions for errors.

Pay Down Debt

The second largest factor for your credit score is how much you owe (30% of your score). The more you owe, the lower your score will be. You would do the same thing if you set up a credit score right? Someone who owes $10,000 in debt is riskier than someone who owes only $100, all else being equal. So a great way to increase your credit score is to pay down as much debt as you can.

Credit utilization [6] is often mentioned in any discussion of debt because that’s the metric most understood. Credit utilization is simply the percentage of your credit limit you are currently using. If you have $1,000 in debt but a total credit limit of $10,000, then you’re utilizing 10% of your debt. The lower this number is, the better.

Stop Opening Credit Card Accounts

Want a free t-shirt? How about a frisbee? Or a blender? You’re dinging your credit score each time you apply for a new credit card. Lenders see it as a big red flag is someone is applying for a lot of credit cards, they think the applicant must really need all of this money otherwise they wouldn’t be applying for the cards!

In addition to credit cards, remember that any request for a loan will fall in this category. The application will result in a “hard inquiry,” which is an inquiry made by a creditor looking to make a decision. On the other side is a “soft inquiry,” which is an inquiry made by a creditor looking for information. If you request your own score, that’s a soft inquiry. When Citi requests it after you apply for a card, it’s a hard inquiry.

Don’t Close Credit Card Accounts

If you don’t use a card, stick it in your desk drawer. Don’t cancel it. A lot of times we feel tempted to cancel and cut up a credit card we don’t use because we don’t want to forget we have it. We don’t want it stolen or we simply want to be rid of it because we paid down the debt. Resist the temptation because when you close the credit card, you are hurt by the credit utilization number. Since the credit limit it taken from your total, the percentage of your total credit immediately goes up. It’s a bit of a moral hazard but that’s how the system works.

Don’t Pay For Credit Score Monitoring

A lot of people use services like MyFICO [7] or other similar services that offer free FICO credit scores [8] to monitor their credit score. I think it’s a mistake, if you are in debt, to continue to pay for the services after the free credit score. You should be taking that money and paying down your debt. Looking at your score won’t improve it, paying down debt will.

If you want to monitor your score, it’s best to use a free service like Credit Karma [9]. They give you your TransUnion credit score, which isn’t technically your FICO score, but it’s still a credit score and you don’t have to pay.

Have I missed a good step to improve your credit score?

(Photo: thetruthabout [10])