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- First, what is a credit score?
If you’re looking to secure a loan – whether it’s personal or for your business – having a healthy credit score will play a big role in the process.
Having a strong credit history makes you a more suitable candidate to receive outside financing as it demonstrates your ability to make payments on time. If ever your business is struggling, money is tight, or an unplanned event takes a negative toll on you or your company, you may need to secure a loan. You’ll want to be sure you have a strong credit score to support your efforts in obtaining one.
If the COVID-19 pandemic has taught us anything, it’s that financial stability in times of crisis is a gamechanger. If you’re a small business owner, having a good credit score gives you a leg up so that you are qualified to obtain outside funding in times of emergency should you need fast access to cash.
On a personal level, a loan could provide you with enough cushion to cover household essentials your family needs, or crucial home repairs that could be detrimental to everyone’s safety if left unattended.
The strength of your credit score will be a primary basis for banks and other lending institutions as they evaluate whether or not you are a reliable borrower. If you think that your current credit score will put you at a disadvantage, this article details eight ways you can improve it, and fast.
First, what is a credit score?
A credit score is a numerical reflection of someone’s creditworthiness based on their track record for paying bills and debts – things like lease payments, mortgages, college loans, and credit card bills. Scores range from 300 to 850, and anything above 680 is generally considered good.
When applying for a loan or credit card, lenders look at your score – essentially analyzing your ability to pay past and current debts – to evaluate if you are able to take on and pay this new debt. It’s a way of calculating their risk in lending to you.
Factors affecting your credit score
The Fair Isaac Corporation (FICO) implemented the concept of a FICO score, which is the three-digit number that summarizes the information on your credit reports. For over 25 years, this has been the standard tool that lenders use for determining a person’s credit risk.
Your FICO score is calculated based on the data gathered from the following categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%).
According to FICO standards, here are the common factors that affect the strength of your credit score:
1. Payment history
Based on your previous transactions and payments, can lending institutions and banks trust that you’ll be able to repay the funds your requesting if they do decide to loan them to you?
As creditors assess your payment history, they’ll question: are you paying your bills on time? If you’re paying late, how long does it take for you to pay them? Do you ever miss you dues? If so, how often? Are there any instances where your account was sent to collections that indicates you weren’t able to pay for longer than expected?
This is also where creditors will check to see if you have other pending debts, foreclosures, bankruptcies, or things of that nature that put you in a bad financial standing.
2. How much you’ve borrowed
Creditors will want to see if you’ve borrowed before, and if so, how reliable you are at making those repayments. This doesn’t mean they’re hoping to find a balance of $0s across the board, they just want to see that you are responsible for paying what you owe. If you have a credit card with a credit limit of $10,000 and you only used $6,000 last month, they’ll want to see that you paid back the $6,000 when it was due.
Seeing what you’re borrowing will also give creditors an overview of how much you owe on different types of accounts – from auto loans to mortgages to credit cards. Credit scoring firms or software will assess if you are responsible enough in handling multiple debts from different types of credit.
3. Length of credit history
Some lenders also look at the length of your credit history. How long have you been using credit? When was the last time you acquired a loan? How old is your oldest account?
Long credit history is beneficial to individuals when getting a new loan because it gives creditors a more accurate picture of your diligence in repaying debts. As long as the length of your credit history is not marred by overdue payments, you have more chances of increasing your credit score.
4. New credits
Have you ever opened several credit accounts in a short period of time? That puts you in a higher risk, especially if you don’t have a credible credit history. FICO scores reflect how often you’re getting new credit.
Every time you apply for a new home loan, for example, an inquiry will be placed on your credit report. When your new loan application has been granted and used, an increased ‘amounts owed’ factor will be reflected in your credit score.
The ‘amounts owed’ factor refers to credit utilization or the ratio of all your credit balances to your credit limits. If you have lower credit utilization vs. your total credit limit, you’ll have a healthier credit score.
Otherwise, activating a new credit card or getting a line of credit would mean that you’re much closer to your credit limit, resulting in a lower credit score.
5. A mix of credit types
Have you acquired credits for different purposes, i.e. credit cards, mortgages, auto loans, installment loans, and/or retail accounts? Another facet creditors look at to evaluate the risk of lending to you is how successful you are in managing different types of credit.
Lenders don’t only look at how you’re managing all your credits, they also assess your compliance in repaying them. They investigate your credit history from these types of credit.
How to build your credit score fast
Now that we know what a credit score is and the different factors that affect it, let’s look at how we can increase it. Here are eight smart ways to do just that, and fast.
1. Pay bills on time
Since payment history accounts for 35% of your credit score, paying your bills on time is the number one solution for increasing it. It’s imperative that you stay on top of your bills.
Create a calendar with alerts that indicate all payment due dates. You can also employ direct deposit which takes the money owed right out of your account automatically so you don’t even need to think about it. You’ll just need to ensure you have enough money in your account so you’re not overdrawing.
Late payments will remain on your credit history for up to seven years so even one late payment can cause lasting damage.
Suppose that you missed a payment by 30 days or more. You can call your creditor right away to ask for an extension and commit to paying your loan at an agreed time so they won’t report your account to the credit bureau.
2. Pay off credit card debts in full
Credit cards serve many different functions. Some may use them solely for paying bills and utilities, others just for emergencies, etc. Regardless of reason, make it a habit to pay off credit card debts in full when the billing statement comes. Your credit score largely depends on your timeliness to pay off debts. That means the sooner you pay your credit card balance in full at the end of the month, the healthier your credit score will be.
3. Borrow only what you can pay
Borrowing can actually be a healthy way to build your credit score as long as you can make all your repayments on time. Only borrow what you can afford to pay back.
This sounds like a no brainer, but resources like credit cards can be easily misused. It can be tempting to use them for things like shopping, travel or other luxury purchases. If not properly managed, you can end up owing more than you can afford which would have a negative effect on your credit history.
On the business side, lenders have become more stringent when approving business credit cards to small business owners. They require personal guarantees as collateral for business credit card applications. This is because lenders want some extra level of security that business owners will pay off their debts even in the event that their business is no longer able to.
Business credit card issuers usually require personal guarantees on top of the cardholder’s credit score. However, there are private agencies that offer start-up business credit cards without personal guarantee. They merely assess applicants based on their credit score and business performance.
4. Avoid applying for multiple credits within the same 12-month period
Making hard inquiries or applying for multiple mortgage or auto loans within a 12-month period can have an adverse effect on your credit score. Some lending organizations might assess you as someone who desperately needs funding, therefore making you a bigger risk.
If you want to boost your credit rating, postpone applying for new credit for a couple of years, or until you really need it.
5. Watch your credit utilization ratio
Credit utilization is the second most important factor in determining your FICO score. It determines how often you’re using your credit, and how much funds you’re getting.
It’s good practice to maintain a 30% utilization of your credit to increase your credit score, on top of paying off all your credit card balances. This also means that you shouldn’t max out your credit as it will reflect badly in your score.
6. Keep old accounts open
Since your credit history provides a clear depiction of your diligence in paying off debts, it’s crucial to keep old credit accounts open for as long as possible. This is because the older your average credit age, the higher your credit score will be. And the higher your credit score, the more trustworthy you’ll be in the eyes of creditors.
You don’t have to close down old credit accounts even if you’re not using them to their full potential. If you have pending balances in other accounts, sticking with old credit accounts will give you a lower credit utilization ratio when assessed on a broader picture.
7. Track your credit score
In contrast with hard inquiries, soft inquiries or merely tracking your credit score won’t affect your current standing. In fact, checking it from time to time will be beneficial to you because it will help you see if it’s the best time to get a home loan or if you need to boost your score.
There are credit monitoring services available to help you monitor the changes in your credit report. It will also tell you if your name is being used for fraudulent activities, such as when a malicious person tries to apply for a credit card using your name.
8. Improve credit mix
Having a mix of installment accounts and revolving credits will help lenders see how responsible you are in repaying your debts. It improves your perceived creditworthiness because you can show creditors a detailed history of all your repayments across different credit accounts.
Since credit scores all boil down to history, assuming that you have a great diversification of credit from mortgage loan to credit cards to your business’ line of credit will already boost 35% of your FICO score.