How To Build Perfect FICO Credit Scores

In 2003 my credit application for a $5,000 loan to buy a used motorcycle was denied. In all honesty, I was absolutely shocked. Although I was only 24 years old (at the time), I had been professionally employed for almost 4 years and I had a decent income, how in the world could I be denied credit?

“How could this be?”, I asked the loan officer.

“I’m sorry Ben, but your credit score of “610” is way outside of our guidelines on used motorcycle loans.”, the loan officer said.

Not lost on my dream, I soon found out that Honda Financial Services WOULD approve individuals with credit scores of 610 so I went out and bought a brand new motorcycle instead, but that is a different story you can read about here

Anyway, the realization that I had a credit score of 610 was extermely dissapointing, I would even go as far to say it was an embarressment. I knew my self-worth should never be indexed to such a consumer driven measurement, but the fact that I had a “bad” credit score was enough to motivate me to take action and improve my credit scores.

Although it didn’t happen overnight, I’m happy to report that after a few short years my three major credit bureau credit scores from Equifax, Transunion, Experian are nearly perfect at 842, 843, and 837 respectively (credit scores range from 300 to 850).

5 Steps to Improving Your Credit Score (FICO Scores):

Before I go any further, I have created this chart below in Excel which shows the 5 major components that make up your individual credit scores (as reported by the three major credit reporting agencies). You can use this as a reference as I address each individual component in the fields below!

Payment History (35%):
As you can see from the FICO Score pie chart above, the largest factor affecting your credit score is your payment history. This includes your track record for making regular and timely payments on all your credit cards, retail accounts, installment loans, finance company accounts, student loans, mortgages, etc.

Your payment history also includes bankruptcies, judgments, suits, liens, and wages attachments (garnishments) related to accounts on your credit file will severely affect your FICO Scores.

Credit lines that have gone into collection will negatively affect your credit history as well as late payments.

The later you are on making your payments (30 days, 90 days, 120 days, etc.) the more negatively that account will affect your credit score.

Other factors that affect the payment history component of your credit score are the balance you owe on any delinquent or overdue accounts, and time (or recency) since you last made a late payment.

The number of past due items on your credit file will also negatively affect your account.

The number of accounts you have in good standing and/or have “paid as agreed” can positively or negatively affect your credit score (the more “paid as agreed” credit items, the better the affect on your score).

How to Improve Your Credit Report Payment History:
The most important thing you can do to improve the payment history component of your three credit reports is to review them and make sure the information being reported is accurate (learn how to get your free annual credit reports from the US Government here).

If you find accounts on your credit report that you know nothing about, you must immediately file a dispute with the reporting agency (learn how to do this here).

If you have a couple of late payments, consider writing a “Goodwill Letter” to the creditor and ask that the late payments be removed, for more on this tactic read my article on goodwill letters. I was successful in having Toyota Financial Services remove a late payment from credit report regarding my leased 4Runner (read all about this silly purchase here).  When the 30 day late payment was removed, my credit score immediately jumped 50 points.

Finally, vow never to make a late payment again! Sometimes things happen, but there is absolutely no excuse for “forgetting” to pay a creditor with whom you have a legal obligation to pay back on a regular basis. If you need help tracking your monthly bills, check out my super easy (and free) Excel based personal finance spreadsheet program.

How much You Owe (30%):
The next biggest factor affecting your FICO score is how much you owe on each of your individual accounts (auto loans, student loans, mortgages, credit cards, personal loans, boat loans, motorcycle loans, second mortgages, etc.).

Perhaps the most important aspect of “how much you owe” is in relation to what your loans’ original balances were. As an example, a balance of $150,000 remaining on a loan that was originally $300,000 will help your score much more than a balance of $150,000 remaining on a loan that was originally $160,000.

The same holds true for your outstanding credit card balances in relation to their limits (sometimes called the utilization rate). Owing $1,000 on a credit card with a $10,000 limit is much better for your credit than owing $9,000 on a credit card with a $10,000 limit.

I’ve been told in the past by “insiders” that a credit card utilization rate of between 0% and 15% of the balance seems to be the “sweet spot” as far as getting the best credit scores. I would shoot for the 0% if I were you.

Another element in the “How Much You Owe” component of your credit score is how many of your accounts have outstanding balances. Generally speaking, the more open accounts with balances you have, the more adversely your credit score will be affected.

How to Improve How Much You Owe on Your Credit Reports:
The single biggest jump you’ll see in your credit score is when you pay down the utilization rate on your credit cards. When I paid down my credit cards from a utilization of about 85% to fewer than 10%, my credit score went from 610 to over 700 in three months. Luckily I was able to sell my motorcycle to pay off a big chunck of my credit card’s balance during this time.

If you really want to improve your credit score, you should consider paying down the outstanding balances on your credit cards as fast and quickly as you can. Learn more about paying off your debts with my debt snowball calculator for Excel.

Length of Credit History (15%):
The third component of your credit score relates to how long you’ve been an active borrower of money.
Factors affecting your score in this component include how long it has been since you first applied for credit. For many people, this was probably their first car or a student loan they took out for college.

Another factor is how long you’ve held specific types of accounts. For instance, you may have a student loan account going back 15 years, but you didn’t get your first credit card until 5 years ago. Had you gotten the credit card 15 years earlier, you may benefit from a slightly higher credit score.

How to Improve the Length of Your Credit History:
There isn’t really anything you can do to enhance the “length of time” component of your credit score. Some personal finance gurus recommend you become and “authorized user” on someone else’s credit card that has a long credit history, but I do not recommend this! It isn’t fair to force your family member or friend into this position!

New Credit History (10%):
Another component of your credit score is how much new credit you’ve applied for and/or received in the recent past (previous 6 months or so). While it shouldn’t hurt your credit score “too much” according to Fair Isaac and Co. (the company behind FICO scores), having a lot of different inquiries on your credit report(s) for mortgages, cars, and credit cards, might be recognized as a red flag by a financial institution.

In general, the more time that has passed since any previous credit inquiries, the higher your credit score will be (but not by much).

How to Improve Your New Credit History:
There really isn’t much you can do here either other than lay off on any new credit applications that you don’t need to make. But it is a catch-22, one of the main ways to improve your credit score is to assume an even mix of various credit accounts (credit cards, mortgages, auto loans, etc.).

Types of Credit Used (10%):
The final component affecting your credit score is the different types of credit accounts you have in your credit file.

This is just my opinion, but I believe having a more diversified portfolio of credit accounts in your credit report (a mortgage, credit cards, student loans, auto loans, etc.), will result in a higher credit score than if an individual had only auto loans, or credit card loans on his or her account.

How to Improve the Types of Credit Used:
This is another small component of your credit file that you really shouldn’t fret that much over. It is what it is! Another major problem of addressing this relatively small component of your FICO score is that it basically says you need to go into debt to improve your credit score! This is just an absolutely ridiculous proposition. It’s kind of like the “tax advantages” of buying something and getting to deduct the taxes from your income. It is a nice perk, but it is never a reason in itself to purchase the item.

Well, that’s all I have to say in regards to improving your credit score! Feel free to leave your own comments, suggestions, and opinions regarding this post in the comment section below!

Too Much Debt?  Download our free Trees Full of Money Debt Snowball Calculator and see how quickly you can pay off your debt.

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