Q. I really want to buy a condo within the next two years but am worried about my pathetic credit score. How can I improve it?
A. Credit scores range from a low of 300 to a high of 850 and are calculated in various ways. It's unclear exactly what formula is used to come up with the final score (seriously—this process isn't totally transparent to anyone, which is odd considering how important credit ratings are), but some things will affect your score more than others.
Lenders are concerned that you'll default on a loan, so you want to show them you're not a financial risk. These steps will help boost your score the most:
Tip #1: Pay your bills on time.
The best way to strengthen your score is simply to pay your bills on time. This sounds obvious, but it works because it shows lenders you take your financial responsibilities seriously and helps you build a track record of prompt payment. Every lender wants to paid on time. Experts say that up to 35% of your credit score is based on your timely payment of bills.
Your current credit rating reflects your payment history, so if you've had problems paying on time in the past, it'll be taken into account. You can improve your score by making sure you repay your bills on time for a few months, so your current bad rating isn't permanent.
Tip #2: Have a range of credit.
Lenders want to see that you can handle a range of credit. The types of credit you have play a part in determining your overall score. Having a combination of personal credit (such as credit cards) and other types of credit (such as a car loan or mortgage) and repaying them consistently has a greater impact on your rating than having only one line of credit.
Tip #3: Don't overextend credit.
On the other hand, if you have too many lines of credit or several giant debts, lenders will consider you a financial risk. Don't take on more credit than you can easily handle. Even if you consistently pay your bills off but your debt load suddenly balloons, lenders will assume that you can't comfortably handle your financial responsibilities.
Studies indicate that people with high debt loads have the hardest time financially when faced with a crisis such as an abrupt illness, unemployment or divorce, so don't take on more than you can reasonably handle.
To avoid this problem, stick to one or two credit cards and one or two other major debts (such as a car loan and mortgage). Borrow only when you need it and make repayments on time. And don't sign up for every new credit card application that comes in the mail. Taking out lots of new credit accounts over a short time period will cause your credit score to plunge because it looks like you can't handle your bills.
Tip #4: Pay off as much of your debt as possible.
If you carry a huge overall debt load, your credit score will suffer. Paying down your debts to a minimum will improve your rating. For example, if you have a $2,000 limit on your credit card and you regularly carry a balance of $1,000, you're not an attractive credit risk to lenders compared to someone who has the same credit limit but carries a smaller balance.
If you're really serious about improving your score, then start with the largest debt you have and start paying it down so that you're using a smaller percentage of your total credit.
When it comes to ratings, the less debt you have the better, so use no more than 50% of your total credit line, experts suggest. This means that if you have a credit card limit of $3,000, pay it down to at least $1,500.
Obviously, it's better if you can pay off your entire balance every month, but what's important is the percentage of your total credit limit you're using—the lower it is, the better your score.
Additional reading
Financial Mistakes Women Make
Saving Made Simple