As people start the process of getting out of debt, they often want to improve their credit score at the same time. While you are digging yourself out of debt, you might as well improve your credit score at the same time. This article is designed to help you to improve your credit score by understanding the credit score formula. At the end of the article I give my 6 step approach to improving your credit score.
Credit Score Formula
- 35% - Late or missed payment - Do you pay your bills on time?
- 30% - Debt amount - How much do you owe to each of your current lenders and how much of a credit limit do you have with them? How close to your credit limits are you?
- 15% - Credit history - How long have you had each account?
- 10% - Kinds of debt - What kinds of debt do you have? Home loans, credit card debt, payday loans
- 10% - Credit report inquiries - How many new accounts or queries have you had?
Understanding Credit Score Formula
As you can see above the FICO score formula consists of 5 parts. In order to improve your credit score you have to improve each part of the formula, but certain factors are given more weight than others.
The first thing to think about is what is the purpose of the credit score. Lenders use the credit score to determine how likely it is that you will repay your next loan on time. The credit score formula focuses on 5 factors indicative of whether a loan will be repaid.
Payment History
The first part of the credit score formula is whether you pay your bills on time. Over one-third of the score is based around this factor and for good reason. There is no better indicator for a lender on whether he is going to be repaid on time than whether you are paying your other lenders in a timely fashion.
Amount Currently Borrowed
The second most important credit score factor is the amount of money you currently owe to each of your creditors and the amount they are still willing to lend you (your current credit limit). The more debt you have, the higher the risk for a new lender that you will not be able to make your debt payments.
Credit History
The third factor looks at how long you have had each account. Lenders like to see borrowers who have a long credit history because this tells them that the data for the other credit score factors is more relevant.
Credit Types
The fourth factor is the type of debt you currently have outstanding. If you have secured loans like home mortgages, unsecured creditors know that they will be behind the secured home loan company in a bankruptcy. Additionally, if someone has a lot of credit card debt, another creditor might be hesitant to extend more unsecured credit.
Credit Score Checks
If there are recent credit report inquiries being made with the credit bureaus, creditors know that you are trying to obtain more credit. This is concerning to a creditor because that creditor knows your current list of creditors, but it doesn't know if someone else is going to extend more credit to you shortly which could raise the risk of non-repayment for the creditor.
Improve Credit Score
Now that you understand the FICO score formula, you are ready to improve your credit score. The good news for people trying to get out of debt is that most of the activities that you are already doing are improving your credit score.
Here are six steps to improve your credit score:
- Get current on all of your bills
- From now on pay your bills on time (THIS IS A MUST)
- Start paying off your debt to get the balances down
- Don't close any credit accounts until your credit score has improved to where you want it to be
- Don't apply for more credit
- Wait patiently as improving your credit score takes time
Many people have a hard time with step number six because they want to see credit report score improvements quickly. But always remember that your credit report score is only important if you are trying to get credit. Since credit is what got you into your debt problems in the first place, focus on paying down your debt instead of accumulating more. Then, you make your credit report score irrelevant.
Once your debt is cleaned up, your credit score will improve on its own.
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