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Credit Scores

Improving one’s credit score is a different process for everyone, depending on one’s circumstances and spending habits. For advice on doing so and insight into faulty consumer thinking, we asked a panel of experts to share their thoughts.

  • What tips do you have for a person trying to increase his or her credit score in a short amount of time?
  • What are some commonly held misconceptions about how credit scores are calculated?
  • What are the most common mistakes people make when trying to improve their credit score?
  • What is the best way for a young person to build credit?

What tips do you have for a person trying to increase their credit score in a short amount of time?

Depends on why their scores are low:

  • First step is to ensure your credit report is accurate. Get a free copy each year. You may wish to get one from each credit bureau (Experian, Trans Union, Equifax) every 4 months, then start over each year. More information about free credit reports here.
  • Do not pay collection accounts that already appear on your credit report, since that will reduce scores for the near term. Scores will increase over time. Ironically, paying off a collection account triggers a “recent remark on a derogatory credit item,” which will reduce scores in the short run. This will occur if the account status changes to “paid.” If you are trying to close a home loan, the lender may approve your loan with a requirement to pay the collection account through the closing, so it will not impact your credit score. Lenders pull a credit report the day they fund a home loan. A lower score may cause delay, a higher interest rate, or even cancel the loan.
  • If you took a “no payment until 2027” loan recently to get the free interest, pay it off. These loans are often offered by furniture retailers and the like. They are new revolving debt, usually charged to the limit with no pay history. Pay it off if possible, and your score can go up more than 60 points within a month, when the account shows paid on your credit report.
  • Get your revolving credit balances down. Mortgage lenders look at “trended data” to see if revolving balances are moving up or down. When revolving (credit card) balances increase, scores will go down. Reducing balances will increase scores. Rising credit card balances are a danger signal that someone is spending more than they earn.
  • Multiple credit inquires for a home loan within a few weeks will not impact your score. However, multiple credit inquires for cars, furniture, appliances, etc. will have an adverse impact on your score. I have seen people who enjoy driving new cars at dealerships have scores reduced due to too many auto loan inquires.
  • The obvious way to have a higher score is to pay your bills on time.
  • One less obvious credit scoring issue is that good credit history is lost when accounts are closed. Bad credit history impacts your score even if you close the account. So, if you have inactive accounts with a good payment history, you may wish to leave it open. Although too many open accounts can also reduce your score. How many accounts should be open? I suggest less than 10. I find most people have 3-5 credit card accounts.

Which are the most common mistakes people make when trying to improve their credit score?

Paying off collection accounts can be a big mistake (see above). However, some collection companies will agree to “delete” (very important distinction compared to shown as “paid”) their credit line on credit reports if the account is paid. They are not supposed to falsely report credit. But, if the account is “deleted” from your credit report, your score will improve.

Another misconception is that if you do not have any open accounts, you will have good credit. People need at least 2 lines of credit for a year to have a score calculated. People need to demonstrate good credit management skills. That is, do not borrow more than you can pay, and pay on time according to terms.

I have seen people who are trying to restore their credit take very high interest rate loans to improve their credit scores. It is very costly. I suggest getting a secured credit card. Use it monthly, with charges that you know you will pay in full each month.

Which is the best way for a young person to build credit?

Pay your bills on time. Do not build up large balances on credit cards. Do not get too many credit cards (more than 3-5). I tell my students that the credit card vendors who come to campus to sign up students should be next to the crack cocaine dealers. Both will not hurt you, as long as they are managed properly. Young people often have a disconnect from getting the money from a loan, and the obligation to pay it back. You credit score is a predictor score that expresses the likelihood that you will pay your debts according to terms. If you manage your debt load and pay according to terms, you will have high credit scores.

 

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