If you want to make a big purchase in the near future or you just 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.
How to Build Good Credit in 10 Steps
Ready to make 2020 the year you finally prove your creditworthiness? Here’s how to build good credit in 10 steps.
1. Duh. Pay Your Bills. On Time. Every Single Month
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.
2. Stay on Top of Your Credit Reports
Sure, it may sound like wishful thinking to hope that your low credit score is just a mistake. But about 1 in 5 credit reports contain inaccurate information, so it’s essential to verify that yours isn’t among them.
Get a free copy of your credit reports from each of the three major bureaus at AnnualCreditReport.com. 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.
3. Establish Credit, Even if You’ve Made Mistakes
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.
Don’t apply for credit willy-nilly. Look for cards that are specifically marketed to help people start or rebuild credit.
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. Sweet! Just make sure the card issuer you choose reports your payments to the credit bureaus.
4. Ask for a Limit Increase. Pretend You Never Got It
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.
5. Prioritize Credit Card Debt Over Loans
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.
6. Keep Your Old Accounts Active
The higher the average age of your credit accounts, the better. So as long as you aren’t paying ridiculous fees, keep your credit card accounts open once you’ve paid off the balance.
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.
7. Apply for New Credit Selectively
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.
8. Still Overwhelmed? A Debt Consolidation Loan Could Help
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, 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.
9. Keep Your Credit Score in Perspective
All the credit-monitoring tools out there make it easy to obsess about your credit score. But your credit score isn’t a report card on the state of your finances. It simply measures how risky of a borrower you are.
So while it’s important to build good credit, remember to look at the bigger picture. Having an emergency fund, saving for retirement and earning a decent living are all important — but none of these things directly affect your credit score.
Also, lenders often look at more than just your credit score when they approve you for a big purchase. Having a low debt-to-income ratio, decent down payment and steady paycheck all increase your odds of approval even if your credit score is lackluster.
Focus on your overall financial picture, and you’ll probably see your credit score improve, too. That will help you reach your goals in 2020 and beyond.
10. Remember: Building Good Credit Is a Long-Term Goal
Yes, your score could go up pretty quickly if you get negative information removed from your credit reports or if your credit card company agrees to a giant limit increase.
But in most cases, improving your credit score is a long-haul game. You’ll usually see your score increase gradually as you make on-time payments and pay down your balances.
Also, know that small credit score changes are normal. Don’t feel like you’re failing if your score drops by a few points one month. It’ll usually bounce back.
The most important lesson is to just keep at it. This isn’t a fad diet. Slow and steady is what wins this game.
Robin Hartill is a senior editor at The Penny Hoarder. She edits and writes stories about bank accounts, credit scores, home buying, insurance, investing, retirement and taxes. She is also the voice behind the Dear Penny personal advice column, which is syndicated in the Tampa Bay Times Sunday business section.