How Credit Scores Work and How to Raise Yours

A credit score is a price tag on you as a borrower. Lenders, landlords and insurers in many states use it to decide whether to say yes and, more importantly, what to charge. Two people buying the same house with the same income can pay very different amounts over the life of the loan because of a few dozen points. This chapter explains what goes into the most widely used scores, which habits move them, which popular tricks do not, and how long rebuilding really takes.

What a better score is worth

The value of a score shows up in the rate. Lenders price loans in bands of credit score, and the gap between bands changes with the market and the lender, so there is no fixed table. But the effect of even one percentage point on a large loan is easy to compute.

On $320,000 over thirty years, the payment at 6.5% is $2,023 a month. At 7.5% it is $2,237, and the total interest rises from $408,142 to $485,495. The same logic applies, at a smaller scale, to car loans and credit cards.

A five-year car loan of $30,000 costs $4,799 in interest at 6.0% and $10,040 at 12.0%. Improving a score is one of the few financial moves that lowers the price of every future loan at once.

What goes into the score

FICO scores, the ones most lenders use, range from 300 to 850 and are built from five groups of information in your credit report. FICO publishes the rough weights for the general population:

• Payment history, about 35%. Whether you have paid on time, and how late, how recently and how often you have not. A payment 30 or more days late is the single most damaging ordinary event, and the effect is larger for someone whose record was clean.
• Amounts owed, about 30%. Mostly credit utilization: card balances as a share of card limits, both overall and on each card.
• Length of credit history, about 15%. The age of your oldest account, your newest, and the average.
• Credit mix, about 10%. Whether you have handled both revolving credit (cards) and installment loans (car, student, mortgage).
• New credit, about 10%. Recent applications and newly opened accounts.

VantageScore, built by the three credit bureaus, uses similar ingredients with different weights. Lenders also use older and specialised FICO versions, especially for mortgages, so the score you see in an app is a useful guide rather than the exact number a lender will pull.

The score reads only what is in your credit report. Income, savings and your bank balance are not in it, which is why someone with a high income and no borrowing history can have a thin or missing score.

The habits that move it

Never pay late. Set every account to pay at least the minimum automatically, then pay more by hand. Because payment history weighs most and late payments stay on the report for up to seven years, preventing one matters more than any other tactic. If you do miss a due date, pay before it reaches 30 days late; most lenders do not report a payment as late to the bureaus until then.

Keep utilization low, especially on the statement date. Card issuers usually report the balance on your statement, not the balance after you pay. Someone who charges heavily and pays in full can still show high utilization. Paying part of the balance before the statement closes, or spreading spending across cards, lowers the reported figure. Scoring models reward low utilization, with the best scores typically showing single-digit percentages; staying under 30% overall is a common working target. Utilization has no memory in most scoring models, so paying balances down can raise a score within a month or two.

Leave old accounts open. Closing your oldest card shortens your history and removes its limit from the utilization calculation. If a card has no annual fee, keeping it open with an occasional small charge is usually the better choice. If it has a fee you no longer want, ask the issuer to switch it to a no-fee card, which typically keeps the account's history.

Apply for new credit only when you need it. Each application can add a hard inquiry, which usually lowers a score a few points for up to a year. When you shop for a mortgage, car loan or student loan, scoring models count several inquiries for the same kind of loan within a short window as one, so compare lenders over a couple of weeks rather than months.

Ask for higher limits rather than more cards. A higher limit lowers utilization without adding a new account, as long as spending does not rise with it. Ask whether the issuer will use a soft inquiry for the review.

Building or rebuilding from a low score

With little or no history, the problem is evidence, not behaviour. Three tools provide it.

A secured card. You deposit cash that becomes the credit limit. Used lightly and paid in full, it builds a payment record. Many issuers review the account after several months and convert it to a regular card, returning the deposit.

A credit-builder loan. Offered mainly by credit unions and community banks, it holds the loan amount in a locked account while you make payments, then releases the money at the end. The payments are reported, so the result is a payment history plus a small savings balance. Compare the interest and fees, since you are paying to borrow your own money.

Authorized-user status. Being added to a family member's long-standing, low-balance card can add that account's history to your report, if the issuer reports authorized users. It helps only if the primary cardholder pays on time and keeps utilization low, because their mistakes become part of your report too.

After serious problems, such as collections or a bankruptcy, recovery is slower. Negative items fade in importance as they age, and most drop off after seven years; a Chapter 7 bankruptcy can remain for ten. Meanwhile, every month of on-time payments and low balances adds positive weight. Realistic progress is measured in months for utilization and in years for a damaged payment history.

What does not work

• Paying a company to "fix" accurate negative information. Nobody can legally remove correct, timely information from your report. Credit repair firms can only do what you can do yourself for free: dispute errors, which the next chapter covers. Federal law bars them from charging before they perform their services.
• Carrying a balance to build credit. Paying interest does nothing for a score. A card paid in full every month builds the same history.
• Opening loans to improve the mix. Credit mix is a small factor, and a new loan adds an inquiry and a new account. Add a type of credit only when you actually need it.