What's Your Credit Score

Your credit score. Those three little digits can have a six-figure impact on your finances. For instance, did you know that on a $300,000 30-year home loan, the difference between a poor credit score and a great credit score is $589 a month, or $212,040 over the life of the loan?

Imagine what you could do with $212,040! You could send a few children to college, invest in a vacation home, buy four or five luxury cars, or save for your retirement.

On the other hand, if you have bad credit, you will search frantically for a car loan, only to be disheartened by large monthly payments due to sky-high interest rates. Even your insurance premium will be higher. Saving for your child’s college tuition? A nice vacation? Forget about it—you won’t be able to afford them. Your unmanageable monthly payments might be turned over for collections. Worse yet, your home might be foreclosed. You probably assume that having bad credit makes you a bad person and, complicating matters, you have to deal with the embarrassment of creditors calling your house all day long.

You get the point: Good credit (a score of 720 or above) is essential for financial freedom and peace of mind. Unfortunately most people do not know the rules of the game. They figure if they pay their bills on time each month, they will have perfect credit. This is simply untrue.

Though the exact formulas for determining credit scores have not been released to the public, we do know that credit bureaus (primarily Equifax, Experian, and TransUnion) determine your credit score by looking at approximately 22 criteria. These criteria work together to form your credit score, with each variable affecting the outcome of your overall score.

The 7 Steps to a 720 Credit Score® program is spawned from these criteria. Though not a quick fix, when practiced consistently, the 7 Steps result in credit scores that exceed 720. Indeed, by practicing just three of these seven steps, borrowers can expect to see huge boosts in their scores. You will see an even bigger boost by implementing all seven! Here are the first three:

Step 1: Keep your credit card balances under 30 percent of your limit. In an ideal world, borrowers would not carry balances on their credit cards, but the statistics are less than ideal. According to FICO, nearly 37 percent of people carry more than $10,000 of debt, and more than 14 percent are using at least 80 percent of their credit card limits.

To increase or maintain your score, your balance on any one credit card should be as low as possible, but never more than 30 percent of your limit. For instance, if you have a $10,000 spending limit on your Visa, keep your balance at no more than $3,000. The debt you carry on a credit card in proportion to your limit is called a “utilization rate,” and credit bureaus respond more favorably if your utilization rate is low. In fact, the worse your credit score, the more you will need to decrease your utilization rate to see a significant boost in your score. Some borrowers with subprime credit (a score of 620 or below) could earn major points (sometimes as many as 100) by paying their credit cards in full. That said, many borrowers’ finances prohibit them from making significant dents in their utilization rate. In these cases, we suggest focusing on one or two credit cards, paying them off as much as possible to see the biggest potential benefit.

Do not be fooled by the myth that if you pay your bill on time and in full each month, your credit score will respond positively. Credit scoring models look at your balance on the day your credit report is requested, so a balance above 30 percent on any given day could damage your ability to obtain credit.

Step 2: Have at least three revolving credit lines. Credit bureaus give higher scores to people with at least three revolving credit cards (e.g., MasterCard, Visa, Discover, or American Express). If you do not have three active credit cards, you should open some.

If you have poor credit, you might not be able to open a typical credit card. In this case, consider opening a secured credit card. Lenders who offer secured credit cards will require you to make a deposit that is equal to or more than your limit, thereby guaranteeing the bank that you will repay the loan. If you do not make your monthly payment, the deposit is applied toward your balance. Alternatively, you can ask a friend or family member with strong credit to add you as an authorized user, which allows you to benefit from the positive standing of the credit account by “borrowing” your friend/family member’s positive credit history associated with the account.

Ideally, you should have between three and five credit cards. Lenders want to be assured that you will not abuse your credit privileges. If you have too few accounts, they do not have proof that you can properly manage multiple accounts, and they will consider you a risky borrower. If you have too many accounts (more than five), they figure you have the opportunity to overextend yourself. That said, if you have more than three credit cards, do not close active accounts. The bureaus agree that once you have opened the excess accounts, the damage is done. In fact, closing them might hurt your score, and it will never help your score. Instead, focus on lowering your utilization rate (Step 1) on your credit cards.

Step 3: Verify the accuracy of your reported credit limits. Credit card companies, who do not want to lose customers to competing creditors, often fail to report your credit limit, or they report a lower limit than you have. This causes your utilization rate to be reported as higher than it actually is, and it negatively affects your credit score, which makes you less appealing to their competitors. If other companies see that you have a high balance and a positive credit score on your credit report, they might solicit your business.

If your credit report shows an inaccurate or unreported limit, contact your credit card company and ask it to correct the mistake. You might also try contacting the credit bureau directly, sending copies of your statements, and asking that it correct the limit. However, neither the credit bureaus nor the credit card companies are legally required to report your limit. It can hurt to ask, and some will temporarily report the limit if you explain that you are making a big purchase and need to immediately boost your credit score.

By following these three simple steps, as well as the remaining four outlined in the 7 Steps to a 720 Credit Score® audio program, you will not only build a good credit score, you also will exemplify to prospective employers and financial counselors good character through your score that will help you in all walks of life.

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