How to get your credit score up, and how not to care
Every Tuesday is Finance & Family Day at Zen Habits.
Reader Jay Dolan asked about credit scores:
Do you have any resources, or info on how to get my credit score up? I went to apply for a car loan and found that my credit score was too low, even for approval at a credit union. It’s getting a bit frustrating because I have some money to put down on a used car, and I have figured out using pear (thanks for that link) that I can afford about a $500/month car payment. I am not looking to spend that much on it, but if I cant get approved for a loan what should I do?
This is a complicated question for me — my answer will really have two parts: 1) how to improve your credit score; and 2) how to make that unimportant to you.
How to improve your credit score
Basically, the way to improve your credit score is to show that you can reliably pay back your debts. To do that, you need to build a good credit history over time — take out small to medium sized debts and pay them back over time (not all at once — show you can do it over a long period of time). Here are some tips:
- Check your credit report. You can get a free credit report once a year from annualcreditreport.com. This will allow you to see if there are any mistakes, and to get an idea of where you’re at. They won’t give you your credit score, but you can at least see what’s on there. If there are errors, take steps to correct them.
- Establish credit accounts. Personal loans or credit cards are usually the best ways to do this. Don’t take out a bunch of junky store credit cards. Take out a few cards that you can keep for a long time. Getting cards with high limits but keeping the balance low is best.
- Pay your bills on time. This is obvious, but late payments will hurt your score big time. Don’t be late.
- Don’t close out old accounts. If you have cards that you’ve held for a long time, keep them under your name, even if you don’t use them. Accounts with long standing are good for your score. Closing accounts hurts your score.
- Get your parents to help. If you’re young and just starting out, you face the Catch-22 situation of not having enough credit history to get loans or credit cards. But you can’t establish that history until you do get them. The answer is to get your parents (or someone with good credit history) to co-sign for you. Make sure your name is on the loan, and be sure that you pay it on time. Once you’ve done that, you have a history. Another solution, if you’re a parent, is to take out a loan with your son or daughter’s name on it, and pay for it yourself. This way you know that it’s being paid on time, so you don’t risk your own credit score, but your child is also getting a positive credit history. Update: A reader pointed out that opening a loan in someone else’s name is illegal … what I meant here is that you could co-sign on a loan with them, with their consent, and pay it back for them to build up their credit. Don’t do it without their knowledge.
Some articles with more depth on this issue:
- Wonkerette: Top Tips to Help Your Credit Score
- CNN Money: Five Ways to Improve Your Credit Score
- MSN Money: Beef up your credit score in 5 steps
- Get Rich Slowly: The Anatomy of a Credit Score
- The Simple Dollar: The FICO Battle: Ten Common Tactical Mistakes When Dealing With The Credit Score Blues
- Consumerism Commentary: Raise Your FICO Credit Score
- The Consumerist: Credit Score articles
How Not to Care About Your Credit Score
Now, having said all that, I have to say that I disagree with the above tips. That is to say, if you want to improve your credit score, those tips will help — but I think you shouldn’t do them.
Why not? Because, for many people, credit is dangerous. Sure, if you’re good at paying your bills on time and you aren’t tempted to spend money when you don’t have it, you’ll probably be fine. But then you probably won’t need this article. For the rest of us, credit cards can be a path to financial ruin. It’s one of the biggest causes of financial problems in the U.S.
So what do I propose instead? In short:
- Avoid credit. Instead of taking out credit cards or loans for the sake of improving your score, avoid them like the plague. Taking out credit for the sake of improving your chances of taking out more credit seems like insanity to me. Instead, save until you have enough money to buy something. This takes patience and a bunch of penny-pinching at first. For example, I just sold my car to pay off my car loan, and got a cheap used van to replace it. I’ll be able to pay off the van quickly, and my goal is to then save my money so I can buy my next vehicle with cash.
- Pay off your debts and cancel your accounts. If you have a lot of debts, pay them off, despite the advice in the section above. Use the debt snowball method.
- Use cash instead. I canceled my credit cards and now pay cash (or make online payments) for everything. It’s convenient, you can’t get into debt or financial trouble, and it makes you think twice about spending it when you physically see it dwindling. See How I Ended My Affair With the Credit Card for more.
- Relax with debt-free bliss. When your debts are all paid off, and you use cash instead, and can pay for your car in cash … well, there’s no feeling like it. It’s incredible.
Will this approach work for everyone? No. Many people need credit, and for those who can handle it, credit can be a good tool if used carefully. Others need to use credit cards a lot for hotels or rental cars, and using cash for these things can be less convenient. But it works for me, and I recommend that you give it some thought.
See also:
- 10 Habits to Develop for Financial Success
- How I Ended My Affair with the Credit Card
- Monitor Your Impulse Spending Urges
- How I Save Money
- What is truly necessary? A guide to living frugal
- Reward Yourself Without Spending a lot
- How to Stop Living Paycheck to Paycheck
- Baby Makes Eight: Raising Six Kids, Part 1 - Finances
- Spewed into the world on 11 April 2007 in Finance & Family |
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- Awesome Archives
Brilliant comments (21)
sommer Says:
April 11th, 2007, 7:53 am
I’m attempting to raise my credit score to purchase a home, my first home. However, I have been turned down way too many times for credit cards, both big and small. So, I’m kind of stuck. I spoke with a loan officer who told me not to apply for any more credit because that will look bad. I need to pay off the few small things on my credit and then try to appy for a credit union account or the credit account where you pay a fee for the credit card. HSBC was one she mentioned.
I’ve paid most of my debits, but I have an old car loan. It was a complete lemon, and I was young, so instead of dealing with the place that sold me the car, I let the loan company take the car and refused to pay them the rest owed.
$3500. it was the principal at the time. It should come off my credit by 12/08. I want to just wait and let it fall off instead of paying that big chunk of money.
So I wait….. not sure if it’s the right thing to do.
Wallet Rehab - Ways to save money Says:
April 11th, 2007, 8:48 am
Sommer, I guess it’s the age old question. There’s what’s morally correct, and what makes sense financially. Personally, I would probably do the same. 3,500 can mean a lot for an individual, and you’ve already been penalized for it as much as you can. And if you pay it off, it will stay live for 7 years after you pay it.
Crazy? huh?
Bob Says:
April 11th, 2007, 9:11 am
I would agree that having accounts in long standing strengthens your credit score, but also having a lot of open account (ie - major department stores, etc) with no balance or history doesn’t help much either. Having lots of accounts open increases your debt to income ratio. Even though you may not have a balance on all these cards, the potential for you to go out and max them out right after you get the home loan is a possibility. Lenders will look at this possibility.
Simple Choice Living Says:
April 11th, 2007, 11:32 am
I got out of debt for the first time in my adult life about six months ago. My wife and I worked on it for almost five years. It was like a credit card fast - a lot of shaking and fevers here and there, but after a while, an inner sense of calm and direction.
Now, we don’t owe anything to anybody. Absolutely no debts whatsoever. **And it feels good.** We are in our thirties, we have no house, but we have freedom and can sleep at night. Each paycheck means I can save a whopping amount of cash in the savings account instead of paying the lords of the credit manor. And now I don’t worry if I were to ever lose my job.
So I recommend getting out of debt and as fast as possible. You can’t predict the future - besides, the economic indicators don’t look that great anyway.
I honestly no longer care what these credit scoring companies think about me. I paid off every bill I ever had and I’m not going to do these silly things to boost my rating (like charging stuff to the credit card). It’s just a cheap way to keep control.
Great article and great site.
Leo Says:
April 11th, 2007, 15:40 pm
@sommer … you bring up a good point that I didn’t cover (I didn’t go very in dept, but it’s covered in some of the links I provided) … in your case, waiting for it to disappear from your credit history is advisable. If a debt is old, it’s often better to let it go away than to pay $50 and turn it into a recent debt.
Another point: if you get a call from a collection agency about an old debt, don’t acknowledge that it’s yours or give them any information. If you do, you have re-set the statute of limitations, which is exactly what that company was trying to do. It’s a scam … they buy thousands of old debts, just hoping to get you to re-set the clock before it runs out, and hoping to collect on just a handful.
@Simple Choice Living: thanks for sharing your great story! It sounds like you’ve got a good thing going, and you’ve done exactly what I was talking about. It’s good to hear from someone who’s actually done it, and to show that it feels great!
Anthony Baker Says:
April 12th, 2007, 0:16 am
Great post.
Here’s a great quote from Dave Ramsey that still sticks with me on the subject of your FICO score. He said this to a woman who was worried about canceling her credit card accounts and going cash-free (which he highly recommends):
“Success is having money, not having the ability to borrow money.”
Damn true, that. Sadly, that’s not the way most Americans think or operate.
Leo Says:
April 12th, 2007, 0:20 am
Excellent comment, Anthony! I love the quote — it’s going on zenhabits.tumblr.com.
John Says:
April 12th, 2007, 11:25 am
RE: tip #4, Don’t close out old accounts
What you state is not *totally* true. Your credit score is affected by a function of your total amount of revolving credit vs. your total amount of debt in revolving credit accounts.
So if I have four credit cards with a combined credit limit of $45,000, and I have a balance on one card of $1,000, the lender looks at that as a potential to increase my revolving debt by $44,000 *after* I take out my loan, which will definitely impact my ability to repay the loan.
This sucks, but not enough is bad, too much is bad, and they won’t tell you where either line is. I’ve kept one or two of my oldest cards, and one card that I actually use on a buy & pay monthly basis, and that seems to work out. Just avoid store cards like Macy’s or JCPenny’s, they don’t help anything at all.
Leo Says:
April 12th, 2007, 16:16 pm
Hi John … thanks for the comment. While what you said about the ratio of amount of revolving credit vs. amount of debt in that revolving credit is true, it’s not the only factor used in determining your credit score. The length of your credit is generally considered to be about 15 percent of your score, so dropping old credit will generally drop your score.
plonkee Says:
April 13th, 2007, 8:15 am
Not having a credit history is all very well for most purposes unless you need to get a mortgage. Maybe property is relatively cheap where you are, but I’m pretty sure that I couldn’t ever save up enough money to pay cash for a house over here whilst paying rent at the same time.
Leo Says:
April 13th, 2007, 8:26 am
plonkee: You’re right, of course — it’s not easy to go without a credit score if you’re looking to get a mortgage. A couple thoughts on this, though:
1) Many people get into a mortgage too soon … having the discipline to wait and be debt-free for awhile before building up a credit history would be a good thing.
2) Mortgages aren’t always the best investment. Especially right now. I would find a low-rent place and invest your money elsewhere, and by the time real estate hits its lowest point, you should have a good amount invested for a down payment.
Leo Says:
April 13th, 2007, 8:49 am
Also, regarding mortgages, I tend to agree with Dave Ramsey. Check out these links:
http://www.mdmproofing.com/iym/weblog/2005/06/dave-ramsey-mortgage-payment.html
http://www.daveramsey.com/etc/cms/index.cfm?intContentID=6971
Greg C. Says:
April 14th, 2007, 5:44 am
Not using credit can be just as “dangerous” or harmful as using it.
Greg C. Says:
April 14th, 2007, 5:47 am
Also, one thing the Ramseys dont really tell you is as business owners they make a lot of money and utilize corporate credit ( their corporations are known to carry balances on credit and pay late) to leverage their businesses ( which in turn of course helps their personal income). I agree with some things, but it’s a lot easier to be a millionaire guru who uses credit and accepts credit cards for services than an “average” working person going cash-free.
Greg C. Says:
April 14th, 2007, 5:48 am
oops, meant “cash-only” or credit-free..
Leo Says:
April 14th, 2007, 8:42 am
Hi Greg … while I understand your objections to Ramsey’s personal contradictions, I think if you consider the ideas themselves without considering the person, some of them have merit. Personally, I think what he preaches, even if I don’t agree with his style, is good advice for most people. It wouldn’t work for everybody, but for a lot of people out there, what he’s saying is exactly what they need to hear. Most people get way too far into debt for their own good. Cutting debt out of their lives is a good thing (whether the advice is coming from a millionaire guru or not).
Not using credit can be difficult, but I’m not sure what you mean by it being harmful or dangerous. Being deeply in debt has ruined many people’s financial lives … while being out of debt hasn’t been nearly as bad for most people. Maybe you could explain a bit more.
John K Says:
April 15th, 2007, 15:48 pm
I totally disagree with your article. Credit is not bad, misusing this valuable tool is bad. The card sits there until a human uses it. If you made a bad choice in selecting a card or use it wrong, don’t blame the card or the Credit Bureau.
If I make an online purchase with my bank’s debit card and it is misused, I might never see that money again, but some credit cards offer a “guarantee” that you will never pay for “fraudulent charges”. I have one of these cards and use is only for online purchases.
What’s more, as long as I pay that charge off within the grace period, I pay no interest. It is like a 25-30 day loan for free.
Keeping a credit account open for long periods of time without using the credit can hurt you in the long run. Are you keeping a credit card with a high credit limit open just to improve your score, but paying $25-60 a year in an annual fee? If so, get a no-fee card and close that old one. If you do carry a balance from month to month, 30% interest adds up much faster than 8.5% Shop around for rates if you intend to carry a balance from month to month.
Finally, many credit card companies will close your account if you dont use them from time to time, so if nothing else, make a small charge on each card once or twice a year and pay it off in the same month.
Leo Says:
April 15th, 2007, 16:21 pm
Hi John K … well, I knew from the outset that many people would disagree with this article. Credit cards seem to be a very deep-rooted issue for many people. As I said in the article, credit can be a good tool if used carefully. But the truth is, for most people, they are dangerous and end up causing financial ruin. The data backs me up on this. You can’t just blame it on the individual people — it’s a long-term strategy for credit card companies to allow people to get into more debt than they can repay, and then allow them to only pay the minimum each month, milking them of high interest rates. This is exactly why they have things like cash back or mileage rewards, no fees, guarantees on your purchases, etc — so they can get people to charge money and eventually pay back a lot of interest.
And there’s no such thing as a free loan — it’s free for you, that time, but for many, it ends up being a very expensive loan. Let’s say I charge $1,000 on my card, knowing that I will get paid before the bill comes, and intending to pay it back right away. Free loan! But then an emergency comes up, and I have to use that money to fix my car or pay for a hospital bill. You might already be prepared for that, but for many people, this is an entirely realistic situation. Now they cannot pay the credit card bill, and in fact will be underwater trying to get back to the surface for many months before they can pay back that $1,000 purchase (with a lot of interest). That’s the danger of credit cards. A much smarter approach is to wait until you actually have the money, and pay in cash. No danger.
Thanks for your comments and tips, John K. I will admit that credit cards may work for you, but they don’t work for many others.
John K Says:
April 15th, 2007, 17:59 pm
I will agree with some of that and your right to disagree! :-) The bottom line is not credit, but misuse of credit that leads to problems. Millionaires owe hundreds of thousands of dollars in debt, but manage it (or some do better than others). How much debt does a multi-billion dollar corporation hold?
On the other hand, if $1,000 of medical bills will turn your entire life upside down and cost you lots of money, I’d rather have that $1,000 in a credit line then not be able to feed my family just from one freak incident. If I don’t have that backup savings, if I have used it up, or if I never planned for it, at least a line of credit might put food on the table until I pay off those other bills. If I really get problems, at least I have fed the family for as long as I could before going belly up.
I do see your point, but the main issue is that the majority of people misuse and abuse credit. Whether it is poor training or the fault of credit agencies that push cards on people starting on the Freshman year of college (even some high-school seniors), is immaterial. You can only blame one person for debt: The person who signs the paperwork. No one held a gun to their head and said “sign for this card and run up a huge debt, or we will go after your family next”.
I personally think more people need to take more responsibility with their own actions and not try to blame credit for “evil”. Many people would not be able to drive a car or live in a house without it. Entrepeneurs open new businesses with nothing but an idea and a line of credit, but they also have a business plan. With the privledge comes the responsibility. I don’t buy the “lemmings” rule about it being an issue because so many people follow. I think, a whole generation of spoiled people were raised to think “charge it, I’ll pay it later”, without worrying about the results of their actions. That is not the fault of the credit agencies, that is the fault of the irresponsible consumer who doesn’t know how to manage money.
David Mottley Says:
July 26th, 2007, 18:06 pm
I have about $17,000 in credit card debt and my credit score is about 628. If I pay off all the debt how quickly and by how much will my score improve?
Carrie Says:
June 24th, 2009, 22:19 pm
I disagree with the statement “no one held a gun to their head and said run up debt,” the credit companies are literally holding you hostage for your promise to pay them back for supposed “emergency money” they lent you, and if you pay late, they will ruin your credit file. I’m shaking in my boots! Credit today is so overrated. The concept being, “I think I will charge this on my Visa with imaginary money, live on a hope and a prayer that I don’t lose my job in the next 14 days so I can pay this bill, and when and if I get paid, pay Visa, have no money again, charge again, pay bill again, it’s a revolving circle of confusion. All this and hoping your hours at work don’t get cut back, you are up the creek without a paddle. Sad state of affairs for a credit rating.
