by Robin Hartill, CFP®
Senior Editor
If you want to whip your finances into shape, here’s a good New Year’s resolution: improving your credit score.
A lot of New Year’s resolutions fail because they’re so extreme. Think of all the bonkers weight-loss and money-saving goals that surface at the start of every year.
This resolution is different. No extreme measures are required. But there aren’t any shortcuts. Building good credit is a goal you need to commit to 12 months a year.
Ready to make 2022 the year you finally prove your creditworthiness? Here’s how to build good credit in 10 steps.
About 1 in 5 credit reports contain inaccurate information. Make sure you access your reports at AnnualCreditReport.com, rather than one of the many websites that offer “free” credit scores but will make you put down your credit card number to sign up for a trial. File a dispute with the bureaus if you find anything you think is inaccurate or any accounts you don’t recognize.
Your credit reports won’t show you your credit score, but you can use a free credit-monitoring service to check your score. (No, checking your own credit doesn’t hurt your score.) Many banks and credit card companies also give you your credit scores for free.
If the bureaus agree to remove information from your credit reports, expect to wait about 30 days until your reports are updated.
Yeah, you knew we were going to say this: Paying your bills on time is the No. 1 thing you can do to build good credit. Your payment history determines 35% of your score, more than any other credit factor.
Set whatever bills you can to autopay for at least the minimums to avoid missing payments. You can always pay extra if you can afford it.
A strong payment history takes time to build. If you’ve made late payments, they’ll stay on your credit reports for seven years. The good news is, they do the most damage to your score in the first two years. After that, the impact starts to fade.
You typically need a credit card or loan to build a credit history. (Sorry, but all those on-time rent and utility payments are rarely reported to the credit bureaus, so they won’t help your score.)
But if you have bad credit or you’re a credit newbie, getting approved for a credit card or loan is tough. Look for cards that are specifically marketed to help people start or rebuild credit. Store credit cards, which only let you make purchases at a specific retailer, can also be a good option.
Opening a secured credit card is one of our favorite ways to build a positive history when you can’t get approved for a regular credit card or loan. You put down a refundable deposit, and that becomes your line of credit.
After about a year of making your payments on time, you’ll typically qualify for an unsecured line of credit. Just make sure the card issuer you choose reports your payments to the credit bureaus. Look for a card with an annual fee of no more than $35. Some secured card options we like (and no, we’re not getting paid to say this):
Increasing your credit limits helps your score because it decreases your credit utilization ratio. That’s credit score speak for the percentage of credit you’re using. The standard recommendation is to keep this number below 30%, but really, the closer to zero the better.
If you have open credit, ask your current creditors for an increase, rather than applying for new credit. That way, you’ll avoid lowering your length of credit, which could ding your score.
The downside of a higher credit limit: You’ll have more money to spend that isn’t really yours. To get the biggest credit score boost from a limit increase and avoid paying more in interest, make sure you don’t add to your balance.
Don’t believe the myth that carrying a small credit card balance helps your credit score. Paying off your balance in full each month is best for your score, plus it saves you money on interest.
Tackling credit card debt helps your credit score a lot more than paying down other debts, like a student loan or mortgage. The reason? Your credit utilization ratio is determined exclusively by your lines of credit.
Bonus: Paying off credit card debt first will typically save you money, because credit cards tend to have higher interest rates than other types of debt.
Provided you aren’t paying ridiculous fees, keep your credit card accounts open once you’ve paid off the balance. Credit scoring methods reward you for having a long credit history.
Make a purchase at least once every three months on the account, as credit card companies often close inactive accounts. Then pay it off in full.
When you apply for credit, it results in a hard inquiry, which usually drops your score by a few points. So avoid applying frequently for new credit cards, as this can signal financial distress.
But if you’re in the market for a mortgage or loan, don’t worry about multiple inquiries. As long as you limit your shopping to a 45-day window, credit bureaus will treat it as a single inquiry, so the impact on your score will be minimal.
If you’re struggling with credit card debt, consolidating your credit card debt with a loan could be a good option. In a nutshell, you take out a loan to wipe out your credit card balances.
You’ll get the simplicity of a single payment, plus you’ll typically pay less interest since loan interest rates tend to be lower. (If you can’t get a loan that lowers your interest rate, this probably isn’t a good option.)
By using a loan to pay off your credit cards, you’ll also free up credit and lower your credit utilization ratio.
Many debt consolidation loans require a credit score of about 620. If your score falls below this threshold, work on improving your score for a few months before you apply for one.
All the credit-monitoring tools out there make it easy to obsess about your credit score. While it’s important to build good credit, look at the bigger picture. A few final thoughts:
Focus on your overall financial picture, and you’ll probably see your credit score improve, too. Remember, though, that while credit scores matter, you matter more.
Now go crush those goals in 2022 and beyond.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. Send your tricky money questions to [email protected] or chat with her in The Penny Hoarder Community.
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