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What is Credit?
Credit is the word used to determine a consumer's lending worthiness. The higher your credit score, the more trustworthy you are as a consumer and the more likely a financial institution is to lend you money. This high score indicates your ability to pay back a debt. The lower the score the less likely you are to be able to pay back your debts. If you are have a low credit score, you may find that it is hard to get money lended to you because your score indicates your ability to repay a debt is low. Banks and other financial institutions do not want to lend to someone they believe may not be good for the debt.
Additionally, if you have a high score and are looking to borrow money, you may find that the interest rate at which you can borrow money is significantly lower than for someone with a low score. This is because the bank considers you a trustworthy investment and does not need a higher rate of return on their investment in order to give you a large sum of money.
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1. Pay Bills on Time
Paying your bills on time will have one of the largest positive impacts on your credit score. One major factor in determining the credit score of any consumer is whether or not you pay your bills on time. A late payment can negatively affect your credit score. A late payment can show up on your credit score as 30 days late, 60 days late, 90 days late, or delinquent for accounts with payments that haven't been made in a significant amount of time. Each account that has a late payment hurts your credit score, and the later the payment on your credit report the more damage caused to your score. Remember, these late payments will not affect your score after seven years, and the longer it has been since a late payment, the better your score will get.
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2. Diversify Your Credit
Having different types of credit may seem to be a negative factor, but will be an asset in attaining a good credit score. Your credit score is determined based on a number of factors. One factor a company will look at to determine credit worthiness is what types of credit you have. If you only use one credit card, ironically your credit score will be lower than a person who uses a credit card along with a line of credit. Similarly, someone who also has a mortgage, home equity line of credit, and personal loan will also have a higher score than a person with less diversity on their credit score. This may appear anti-intuitive, but the more types of credit you are able to handle concurrently, the better you will be at juggling an additional debt, thus the more creditworthy you become to creditors. So start building credit history by diversifying your credit liabilities with multiple resources.
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3. Add Rent to Credit
Getting rent payments on your credit score is just one more way to show a good history of on-time payments. A recent change in the credit system has allowed landlords to send rent payment information to a credit agency. While this may not always be an option, requesting your landlord send in your payment history each month to a credit agency will help show a history of good credit over time. This may be difficult, as it often is costly for landlords to report information to credit agencies.
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4. Give It Time
Giving your score time to improve is the hardest tip for consumers to take. A credit score determines a person's history of good credit practices. The longer you show good credit, the better your score will be. You may have never paid a late bill, had a foreclosure, or defaulted on a loan but your score may still not be as good as someone else who has five more years of credit history than you do. The reason is that time is a factor in computing your credit score. The longer your history of good credit, the better your score will be.
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5. Start Your Credit Early
Starting early on your credit is the best tip for new credit users. The earlier you start creating a good credit history the better. This ties in with tip number four, if you start your credit early, you have more time to show a good credit history. Helping your kids start their credit early can help them in the long run. Time is one of the biggest factors in determining a credit score and the longer you can show you have good financial habits, the better a bank or other financial institution will view you as a potential client.
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6. Lower Your Balances
Lowering your balances is the best way to immediately boost your credit score. The lower the balance on your credit cards and loans, the better your score will become. Your credit score is determined using information about a ratio of credit used to credit available. So, if you have $1000 worth of available credit and you've used $700 of it, you will have a lower score than someone who has a balance of only $200.
Even if you pay off your credit cards each month in full, it may not show up on your credit score. The date the balance is reported to a credit agency is different for each account. If you use your credit cards heavily, it is wise to pay off the full balance of the card in advance of the day the balance is reported to the credit agency. This will guarantee a low balance, or a balance of zero, is reported on your credit report for each card or line of credit.
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7. Close Old Accounts
Closing old accounts can positively affect your credit, but must be done with caution. This does not always help your credit score, but sometimes it does. Herein lies the problem: your credit score uses the average time each account is open as the length of time for your credit report. The longer that time is, the better your score will be.
So, if you have a large number of credit cards that were recently opened and one that was opened for 20 years, then your score for average length of time open will be much smaller than 20 years. However, if you closed those recent accounts, the average time the account has been opened will increase drastically thus improving your score.
On the contrary, if you have large balances on credit cards, closing accounts will hurt your score because it will lower the ratio of credit used to credit available. If you have two cards with limits of $500 and one has a balance of $200, you currently have a ratio of 20% of credit available being used. However, if you cancel one of those cards, you suddenly have 40% of available credit being used. This ratio hurts your score. Weigh the benefit of closing old accounts before you do so in order to improve your credit score.
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8. Open a New Credit Card
Opening a new credit card can help your available credit ratio, thus improving your score. In the same way that closing old accounts can help and hurt your score, so can opening a new credit card. By opening a new credit card, you can increase the ratio of available credit and balances, thus improving your score. However, a new credit card will lower the average length of time each card has been opened, thus hurting your score. There are benefits to opening a new card, but those may be outweighed by the costs and should be examined prior to opening these new accounts.
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9. Get a Loan Cosigner
Getting a co-signer for a loan will help to improve your credit score by having a second person make sure payments are made each month on time. Having a second person sign on a loan will help your credit history. If you are a co-signer with another person who pays their loan on time every month in full, then this can help your credit score as well without adding the financial liability of an additional payment. The problem with this step is that too often a person will co-sign to help out a friend or family member with less-than-perfect credit and this will end up hurting their score when their friend or family does not fulfill their financial obligation.
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10. Get Added to Someone's Credit
Getting added to someone else's credit, such as a credit card or loan, can be beneficial to your credit score. Their good habits are transferred to your score and will help to boost your credit score. Much like any other tip for improving your credit score this will take time but can be a good way to have their financial responsibility help your score. This is beneficial to do for children or dependents with no credit history; and having no credit history can be almost as bad as having a bad credit score.
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Recap and Summary
Credit history is built from your history of using and paying credit on time. There are a variety of factors that go into a credit score, from the length of time your history has existed to the types of credit you utilize. Among the strategies available to help improve your credit score, most will do the most difference if given a proper amount of time to work. Though there are some tips to help give an instant boost to your credit score, such as paying off balances and being added to another person's credit with a history of good payments. The best thing you can do to improve your credit score is to pay your bills on time every month and keep low balances over time. The longer you do this, the better your score will become, so start good habits today and start building credit history to help improve your score.
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Bankrate.com: What is a Credit Score? http://www.bankrate.com/finance/credit-cards/what-is-a-credit-score.aspx
Federal Reserve System: Improving Your Credit Score http://www.federalreserve.gov/consumerinfo/fivetips_creditscore.htm
Photos by Michelle Friesen, 2011