Credit scores play a big role in our financial lives. A good score helps you get approved for an apartment faster and can mean better rates on a car loan or insurance. Yet a large number of Americans have poor credit, often because nobody explained which factors actually move the score or how to improve them. If you want a brighter financial future, start by understanding how good credit is built.
What affects your credit score?
FICO, the score most lenders use, weighs five factors. We call them the Big Five:
- Payment history (about 35%). Whether you pay on time.
- Amounts owed (about 30%). How much of your available credit you are using.
- Length of credit history (about 15%). How long your accounts have been open.
- Credit mix (about 10%). The types of credit you have, such as cards and installment loans.
- New credit (about 10%). How often you apply for new credit (inquiries).
Payment history and amounts owed carry the most weight. That is why missed payments and growing balances are the most common causes of bad credit. If thousands of dollars in debt is what is holding your score down, the best move is a repayment plan that gets rid of it.
The debt snowball plan
The debt snowball is a debt reduction strategy that works well when you have several debts, such as credit cards and loans. You pay the minimum on everything, then put every extra dollar toward the smallest balance. When it is paid off, you roll that payment into the next smallest, and keep going until all of them are gone.
It works because early wins keep you motivated. If you start with your largest debt, progress feels slow, and slow progress makes it hard to stick with the plan.
There are other ways to tackle debt, too. A nonprofit credit counseling agency can help you build a budget or a debt management plan. Whatever you choose, the most important thing is to have a plan and stick with it, because low debt and on-time payments are the foundation of a strong credit score.
Want help understanding what is on your credit reports? Book a free consultation.
Sources: Ramsey Solutions on the debt snowball, myFICO on what is in your credit score.