If you understand how credit works, you can use it to build a great credit score.
SINCE MARCH IS NATIONAL Credit Education Month, U.S. News & World Report conducted a survey to find out if consumers could answer a series of credit-related questions correctly.
Among other findings, the results showed that one-third of respondents are unclear about what factors impact their credit score. But before I dive deeper into the results, let’s start with a quick overview of how credit scores work.
How Is Your Credit Score Calculated?
The most common credit score used by lenders is the FICO score, so that’s what I’m focusing on here. According to myFICO, here are the five factors that make up your FICO score:
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- New credit: 10%
- Credit mix: 10%
Your payment history and amounts owed make up 65% of your score, so paying attention to these factors can really improve your credit score. Amounts owed refers to your credit utilization ratio, which is the amount of credit used compared with the amount of credit you have available. Keeping your ratio under 30% can benefit your credit score, but keeping it under 10% does more to boost your credit score.
Understanding the basics of how to improve your score – timely payments and keeping low credit card balances – will help you achieve or maintain a high FICO score.
What Hurts Your Credit Score?
Let’s start with the good news: Just under 56% of respondents correctly identify missed payments as a credit score buster. Responses got a little murkier from there.
Here are the findings:
Less than a third know that their utilization ratio should be less than 30%.
Almost 15% say that checking your credit report lowers your score, but it has no impact on your score at all.
Only 23% know that closing a credit card could lower your FICO score.
The reason closing a credit card can lower your score is because you are losing available credit. So that makes your utilization ratio go up, which makes your credit score go down.
What Helps Your Credit Score?
More than one in four respondents say that increasing your income would increase your credit score. Your income is considered by a lender when you apply for credit. But your income has no impact on the calculation of your credit score.
Again, respondents are aware that paying bills on time is important. Here are more findings:
- About 60% know that on-time payments help their credit score.
- Only 31% say that using less than 30% of your available credit boosts your score.
- Around 31% can’t name which factors improve your score.
- There’s one myth that seems to persist even though it costs consumers money. More than 44% say carrying a balance on a credit card is necessary to build credit. When you
- carry a balance on a credit card, you’re paying compound interest on it. This not only costs you money, but it can also lead to credit card debt.
You should always pay your balance in full by the due date. You do not have to carry a balance to boost your credit score. An excellent FICO score is free as long as you practice good credit habits.
How to Check Your Credit Report
While nearly 41% had checked it in the last three months, 24% had never checked their credit reports. For those who don’t know how to check your free credit reports, you’ll be happy to hear it’s super easy.
You can request all three of your credit reports at AnnualCreditReport.com. Normally, you’re entitled to one free report from each of the three credit bureaus every 12 months. But due to the COVID-19 pandemic, Equifax, Experian and TransUnion are offering free reports weekly until April 20, 2022. So, take advantage of this, and review your reports often.
Right at 24% of survey respondents say that married couples share a joint credit report and credit score. Whether you’re married or not, you have your own credit reports and your own credit score.
How to Use Credit Wisely
Like many things in life, credit has a good side and a bad side. Use credit responsibly, and it can help you build a great credit history and an excellent credit score. But if you carry a balance from month to month, you’ll pay interest on your purchases, which leads to credit card debt.
Here are three steps you can take to make sure you stay away from the wild side of credit cards:
- Educate yourself.
- Practice great credit habits.
- Resist retail therapy.
- Educate yourself.
- When asked where they learned about credit, almost a third of respondents had
- primarily learned by conducting their own research.
Other responses:
- Almost 23% learned from experience.
- Less than 10% learned from their parents.
- Nearly 6% understood credit because they got credit counseling.
- Only 3% learned about credit by taking a class at school.
- Note that very few learned about credit from their parents or at school. If you’re a
- parent, make it a priority to educate your kids before they go to college.
If you’re trying to figure out how to learn about credit now, read personal finance books, visit personal finance websites and ask your credit card issuer questions about anything you don’t understand.
Practice great credit habits.
Nearly 23% say they do nothing to stay out of credit card debt. Using credit cards means you have to be diligent to avoid debt. You should always have a budget and track spending. If you don’t know how much you’ve spent with your credit card, you won’t know when to put the brakes on your credit card use.
In addition, pay your bills on time and keep low credit card balances during the month. And most importantly, pay your credit card bill in full every single month.
Resist retail therapy.
The pandemic created a situation where many of us did more online shopping than usual. The temptation to reduce stress with a little retail therapy can sneak up on you.
You might have been online ordering a grocery delivery, which is an essential purchase. But maybe you saw an ad that caught your eye, and before you know it, you’re on Amazon looking at wireless earbuds.
It’s easy to fall into the retail therapy trap. But that’s where your budget comes into play. If you can afford it, give yourself a reasonable budgeted splurge each month. This keeps you from feeling deprived, but keeps you out of credit card debt.
