MythTip: Building Your Credit Score

Okay, I may be guilty of perpetuating a money myth. In my post you must use credit to get credit I am afraid I may have given the impression that the quality of your credit history and score is not an important consideration for lenders (see how easily these myths can spring up?). That was not the point of the post. The point of the post was to show how important it is to make sure your income exceeds your expenses by fair margin, and that by using credit heavily, you reduce your available income and thus hurt your credit worthiness in the eyes of lenders. However, your credit score is a very important factor in your life. It can affect your work, your insurance rates, and, of course, your credit worthiness.

Tricks of the Trade

Your credit score is a strange creature. The most bizarre things can hurt it, and even more bizarre things can improve it. Let’s take a look at some tricks of the credit scoring game.

Increase your credit limit. An important factor in your credit score is a ratio called the “debt utilization ratio”. This ratio is calculated by the following formula:

Debt Balance ÷ Available Debt

For example, if you have two credit cards each with a credit limit of $2,000, then your available debt is $4,000. If you have a balance of $300 on one card and $700 on the other, then your debt balance is $1,000. This would give you a debt utilization ratio of $1,000 ÷ $4,000 = .25, or 25%. Generally, the people who keep their debt utilization ratio around 10%-20% have the best credit scores. A low debt utilization ratio shows lenders that you use your credit wisely, not excessively. Just make sure that you are making prompt payments!

Don’t wait for your bill to pay down your card. The credit card company reports the balance on your credit card to the credit reporting agencies at the time that they process your monthly bill. If you have a high balance at the time the bill is printed, then that is the balance that goes on your credit history, regardless of when you pay it off. So, if you have a high balance and pay it off after you get your bill, the high balance will still hurt you. Go check your card online and make payments on it, even when your bill has not been sent to you yet.

Keep a small balance on your card when your bill is processed. If you pay your credit card off comlpetely right before your credit card company sends you your bill, it will show a zero balance when they submit the bill to the credit reporting agencies. By keeping a balance on the card to show up on the bill, you how that you are using your credit, and by keeping that balance small you prove that you are using it wisely. After the bill has processed, immediately pay off the remaining balance so that you don’t have to pay any interest. A good strategy would be to make regular payments to your credit card and keeping the balance always below 20%, and making sure that you pay the full balance after your bill is printed. By doing this, you will improve your credit score quickly, and you won’t have to pay any interest.

Be Careful

What creditors are looking for in your credit score is evidence that you are in control of your own finances. If you cannot have a credit card and remain in control of yourself and your spending, then do not use credit cards. If you do, your lack of control over your finances will be evident and you will have a poor credit score. Be careful to not get carried away by credit, because it is very tempting to some. Don’t be fooled by the low payment the credit card requires. Always pay your card off in full each month, never ever pay interest on a credit card unless you absolutely must. Maintain control of yourself and your finances, keep a close watch on your credit history and your credit card balances, and watch your budget and expenses. If you do so, you will eventually find yourself living the lifestyle you have always wanted.

Posted on 1 Oct 2008