Note: You can find definitions to the underlined words at the end of the article.
If you're dissatisfied by your credit score, you're not alone. In 2017, the average American had a credit score of 675. In general, a score above 700 is what’s considered “good” credit by lenders (these numbers are based on credit scoring models ranging from 300-850).1 If as a country we’re averaging below what’s considered “good” credit, this means we have some work to do! Luckily, your credit score is not set in stone and there are ways to improve it. The key is knowing what impacts your credit score.
According to researchers at Credit Sesame (a credit score and financial management platform), these are the 5 components that make up your credit score and 5 tips on how to improve them:
1. Payment history
Your bill payment history (on both installment loans and revolving credit accounts) makes up the largest portion of determining your credit score and is therefore the most important component to fix.
Credit score weight: ~35%
Tip: There’s nothing you can do about missed payments in the past, but in order to prevent missing future payments, set up autopay to cover your account minimum (if you’re still paying your bill by check, consider switching to online payments to make paying your bill faster and more convenient). If possible, you should pay off your balance in full, but by turning on autopay to cover at least your minimum then you’ll never miss a payment again. If you do miss a payment, pay it as quickly as possible because in most cases, the longer a bill goes unpaid the more damage it will cause to your credit score. Also, it is worth reaching out to the lender if you do have a late payment. If it was an honest mistake they may be understanding and it could prevent them from increasing your APR (Annual Percentage Rate).
2. Credit utilization
This is the amount of revolving credit you’re currently using divided by the amount of revolving credit you have available, also known as your credit utilization ratio (note, this measurement does not factor in debt from installment loans like a mortgage or auto loan). Credit scoring models often consider both your per-card credit utilization and overall credit utilization. In both calculations, good credit utilization is generally considered to be less than 30% of your revolving credit limit, meaning anything above 30% can cause your credit score to drop. Less than 10% credit utilization is considered excellent.2
Credit score weight: ~30%
Tip: This is the second most important factor in determining your credit score and luckily, it’s the easiest to fix! Most credit card holders carry a balance month to month.1 If you’re carrying a balance on your card(s) that’s over 30% of your credit limit(s), simply make it a priority to pay down as soon as possible. Again, you should always try to pay off your full balance, but if that’s not possible try contributing a fixed amount from every pay check to slowly chip away at your debt and avoid paying unnecessary interest. Also, regarding credit utilization, it’s important to know that even if you pay off your bill(s) in full every month, if you’re using over 30% of your available credit at any given time, it can still negatively affect your credit score.
3. Age of credit
This is a combination of how long you’ve had credit and the average age of your accounts. The longer your history of managing accounts responsibly, the higher you’ll score.
Credit score weight: ~15%
Tip: This is tricky because we all must start building credit somewhere and unfortunately, the only way to prove you can manage it responsibly is over time. In fact, “Americans with an average account age that’s greater than 11 [years] have an average credit score that’s 112 points higher (745 vs. 633) than those with an average account age between 5 and 10 [years].”2 While there’s no quick fix to improving the age of your credit, you can avoid lowering the average age of your accounts by not opening too many new lines of credit at once (this is especially important if you’ve only recently established your credit history). You can also lengthen your average age of credit by leaving old credit card accounts open, even if activity is minimal. Added benefit – this may help lower your credit utilization ratio as well!
4. Credit mix
This simply means having a diverse assortment of credit including installment loans (those with level payments like a car loan or mortgage) and revolving credit (like a credit card).
Credit score weight: ~10%
Tip: Good credit is all about proving your responsibility to lenders, and consumers with a diverse credit mix demonstrate the ability to manage multiple types of credit which lenders like to see. To score high in this category, you need to have a variety of open accounts that show lenders you are capable of making regular fixed payments, as well as making regular charges and paying them off. Also, remember that opening new accounts can lower your average account age, hurting your score even more.
5. Number of credit inquiries
Whenever you apply for a new credit card or loan it’s considered a “hard” inquiry on your credit report, which can lower your score for up to 6 months. (Note, “soft inquiries,” such as self-checks, employer checks and prequalifying checks for special promotions will not affect your score).
Credit score weight: ~10%
Tip: Although in some cases it might make sense to open a new credit account, like to lower your total credit utilization or increase your credit diversity, too many “hard” inquiries on your credit report looks risky to lenders and even just one may temporarily lower your score. Its affect will vary depending on the length of your credit history, but in general a hard inquiry will stop affecting your score after 12 months (note it still remains on your credit report for around 24 months). More than five inquiries per year is considered high, so plan ahead when it comes to taking out a loan or opening a new credit card to ensure there’s plenty of time in-between. Also know that if you’re shopping for a mortgage, student loan or auto loan and make multiple inquiries within a short period of time it will only count as a single inquiry.3
If you aren’t already, start monitoring your credit score regularly. There are a ton of different free online resources for checking your credit score. Some of the most popular sites include: creditkarma.com, freecreditreport.com, creditsesame.com, nerdwallet.com, and mint.com. If you have a credit card, it’s also possible the provider offers free credit scores if you login to your account online. In order to track your credit score accurately, make sure you note the website you got it from and which credit reporting agency it used (there are three national credit bureaus that issue credit reports which you score can be based off of: Equifax, Experian and TransUnion). If you ever notice an unusual change in your credit score, it’s a good idea to check your full credit report and make sure there are no discrepancies. All three credit bureaus offer a free credit report once every 12 months (remember, this is considered a “soft” inquiry and won’t hurt your score).
Building good credit takes time, and if your credit score isn’t up to par, you’ll want to take action to improve it ASAP. Having good credit might not seem important now, but when you need to take out a loan, apply for a mortgage, or open a new credit account it most certainly will be! If you’re worried about your credit score, having trouble managing debt or feeling uncertain about your financial future, meeting with a financial planner can help get you on track and provide peace of mind. Similarly, if you need help planning for a major purchase like a home, or a major life event like starting a family, a financial planner can help you asses your situation and figure out the best way to finance your expenses.
A credit score is a statistical number that evaluates a consumer's creditworthiness and is based on credit history. Lenders use credit scores to evaluate the probability that an individual will repay his or her debts. A person's credit score ranges from 300 to 850, and the higher the score, the more financially trustworthy a person is considered to be.4
A loan that is repaid over time with a set number of scheduled payments.
Type of credit that has a charge limit set by the lender but allows you to determine how much you will charge (within your limit) and how much you will pay off each month.
Short for automatic payments – autopay is simply recurring payments of a certain amount that you authorize someone to collect automatically from a separate bank account every month.
APR (Annual Percentage Rate):
The annual rate charged by a credit card company for borrowing – usually charged monthly on any remaining account balance.
Credit utilization ratio:
A percentage of a borrower’s total available revolving credit that is currently being used.
Please note: Financial advice should be tailored to individual circumstances and the content of this article should not be viewed as recommendations. This article is not an endorsement of any particular product, service or organization; nor is it intended to provide financial, tax or legal advice. It is intended to promote awareness and is for educational purposes only. The specific applications and services noted are not necessarily endorsed by John Hancock or any of its affiliated businesses.
Advisory services offered through John Hancock Personal Financial Services, LLC, an SEC Registered Investment Adviser. Boston, MA 02210. 888-955-5432.