How to improve your credit score
October 26th, 2011 - 80 Comments
Here’s something that you’ll almost never see on a financial TV show:
Consider 2 people…
- One has great credit
- The other has poor credit
In their 30s, they decide to buy houses of similar prices.
How much do you think they pay?
Simply by virtue of having different credit scores, the person with poor credit will pay over $68,000 more than the person with excellent credit.
Over $68,000. How many lattes is that worth?
THAT is the power of having a great credit score. Yet most “experts” will either (1) continue yammering on about lattes and clipping coupons, or (2) give worthless, high-level advice like “Improve your credit!” (Okay…how? Jackass.)
They do this because lattes and coupons are obvious and top-of-mind. In psychology, this is called the availability heuristic.
But just because something is obvious and top-of-mind doesn’t mean it’s important, which is why I love mocking dumb financial experts whose advice doesn’t work.
My goal with IWT is to show you what’s beneath the surface — what’s important, but not obvious — to get you BIG WINS.
So today, I’ll show you a step-by-step process to improve your credit score, which is one of the top 10 Big Wins you can get in your life.
The tactics: How to improve your credit score
You don’t need to become a credit weirdo like me and read 50 books on credit optimization to raise your credit score. You can actually ignore most advice and simply do a few, key things to dramatically improve your score.
In fact, there are 3 major steps that will have the biggest impact in improving your credit score. Check it: Here’s what your credit score is composed of:
I’m not going to give you 50,000 tips on how to improve your credit score. Instead, I’ll show you 3 tips to raise your credit score that work:
1. Automate your credit card payments
35% of your score (the biggest portion) reflects your payment history, so even missing 1 payment can cause your credit score to drop 100 points, jack your APR up 30%, add $200+/month to your monthly mortgage payment (insane, I know), and more.
Set up automatic payment using my IWT system. I even recorded a video showing you the exact accounts that should pay each other, using my amazing artistic skills.
Notes on automating your payments:
- Since 35% of your credit score is based on your payment history, setting up automatic payments is your Big Win here.
- Instead of doing what most people do (wait until the end of the month, then try to remember to pay…and when they forget, they get slapped with huge penalties), set up automation so you never have to worry about this again.
- You should ideally be paying off your entire credit card balance each month, but if you can’t, you can still improve your score by paying at least the minimums, on time, every month.
Here’s the video on automating your accounts:
2. Pay off your goddamn debt
If you have credit card debt, read on…
Too many idiots decide that since they have debt, they should game the system and play the 0% balance transfer game, switching balances from card to card to save a few percentage points on debt interest. Yeah!! Let’s stick it to the man!
What I’ve found is that they spend more time transferring balances from card to card instead of actually paying their debt off. Honestly, get a life. The credit card companies are smarter than you, so if you try to game them, it’s only a matter of time before they destroy you.
Instead, here’s what I want you to do:
- Go to http://www.whatsthecost.com/snowball.aspx (my favorite debt calculator) and plug in your numbers
- You will see EXACTLY how long until you pay off your debt. Stick to the plan via automation (see step 1 of this email)
- Decide, optionally, to use the negotiation material from Chapter 1 of my book. It doesn’t always work, but when it does, you may get results like this…
The results someone got 2 days ago using my book to negotiate their APR down.
3. Keep your old accounts open — and set up a $5 monthly charge on them
So many times, when people get motivated to “do something” about their credit cards, the first thing they do is close all the cards they haven’t used in a long time. Sounds logical! Let’s clean out the old cobwebs in our wallet!
In general, however, this is a bad idea: 15% of your credit score reflects the length of your credit history, so if you wipe out old cards, you’re erasing that history.
Plus, you’re also lowering your “credit utilization rate,” which basically means (how much you owe) / (total credit available).
Bottom line? Even if you don’t use a card, consider putting a small charge — say, $5/month — and automating it each month. In this way, you ensure your card is active and maintains your credit history.
Notes on keeping your accounts open:
- For nerdy people (aka half my readers), here’s the math of your credit utilization score — plus a little-known caveat: “If you close an account but pay off enough debt to keep your credit utilization score the same,” says Craig Watts of FICO, “your score won’t be affected.” (Most people don’t know this.) For example, if you carry $1,000 debt on two credit cards with $2,500 credit limits each, your credit utilization rate is 20% ($1,000 debt / $5,000 total credit available). If you close one of the cards, suddenly your credit utilization rate jumps to 40% ($1,000 / $2,500). But if you paid off $500 in debt, your utilization rate would be 20% ($500 / $2,500) and your score would not change.
- If you’re applying for a major loan— for a car, home, or education—don’t close any accounts within six months of filing the loan application. You want as much credit as possible when you apply. (However, if you know that an open account will entice you to spend, and you want to close your credit card to prevent that, you should do it. You may take a slight hit on your credit score, but over time, it will recover—and that’s better than overspending.)
Bonus! Raising your credit score if you DON’T have CC debt
I’m serious about this warning: This tip is only for people who have no credit card debt and pay their bills in full each month. It’s not for anyone else.
It involves getting more credit to improve your credit utilization rate, which is simply how much you owe divided by your available credit. As I mentioned, this basically makes up 30 percent of your credit score. For example, if you owe $4,000 and have $4,000 in total available credit, your ratio is 100% (4,000 / 4,000 x 100), which is bad. If, however, you owe only $1,000 but have $4,000 in available credit, your credit utilization rate is a much better 25% ($1,000 / $4,000 x 100). Lower is preferred because lenders don’t want you regularly spending all the money you have available through credit—it’s too likely that you’ll default and not pay them anything.
To improve your credit utilization rate, you have two choices: Stop carrying so much debt on your credit cards (even if you pay it off each month) or increase your total available credit. Because we’ve already established that if you’re doing this, you’re debt-free, all that remains for you to do is to increase your available credit.
Here’s how: Call up your card company and ask for a credit increase.
You: “Hi, I’d like to request a credit increase. I currently have five thousand dollars available and I’d like ten thousand.”
Credit card rep: “Why are you requesting a credit increase?”
You: “I’ve been paying my bill in full for the last eighteen months and I have some upcoming purchases. I’d like a credit limit of ten thousand dollars. Can you approve my request?”
Credit card rep: “Sure. I’ve put in a request for this increase. It should be activated in about seven days.”
I request a credit-limit increase every six to twelve months, like clockwork. Some people find romance in sending flowers to their significant others. I find it in talking to Delores, my friendly credit card rep, every 6 months.
Remember, 30 percent of your credit score is represented by your credit utilization rate. To improve it, the first thing you should do is pay off your debt. If you’ve already paid off your debt, only then should you try to increase your available credit.
3 things to remember when improving your credit score
- Improving your credit score is one of the top 10 financial Big Wins you can have. While others are scrounging around and worrying about ordering a medium Diet Coke, you can focus on something that will pay off with tens of thousands of dollars when you make the large purchases that we’ll all make in our lives.
- Dumb people like to do everything (e.g., balance transfers) EXCEPT doing what really matters: Automating, Paying That Goddamn Debt Off, and Keeping Old Accounts Open. Stay focused on these 3 steps and your score will improve over time.
- Improving your credit scores are a marathon, not a sprint. Give it a few months before checking. To check your credit score right now, check out myfico.com.
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