Play to win: Follow these savvy tips to improve your credit score.
The rules of the credit score game are cloaked In mystery.
Instead of laying out an obvious, intuitive set of guidelines, the system often manifests as finicky and opaque. For example, paying your bills on time is not enough to guarantee a good credit score. And those who have seemingly done everything right can still get hit with a 30-point reduction in their Fair Isaac Corporation (FICO) score because they aren’t aware of all the elements that go into this complex calculation.
Let’s say you have the optimal number of credit cards (three to five), always pay your balances on time, and keep the balances low. You also have a mortgage with no late payments, no recorded interactions with collections, and no errors on your report to bring your score down.
You’d think these factors alone would result in a perfect credit score, but they don’t. In fact, you could get docked up to 30 points because you’re missing a critical piece on your report: an installment loan.
What is an installment loan?
An installment loan is granted for a set period of time with a fixed minimum payment. If you make the minimum payment (and not a dollar more) every cycle, the loan will be paid off at the end of the established term. It’s usually possible to pay off the loan early by tendering more than the minimum payment, but doing so will not lower your minimum payment.
Consider a car loan for example. At today’s rates, if you get a $20,000 five- year loan for a car, you’ll be paying about $360 per month for the next 60 months—or sooner if you pay more than the minimum.
For whatever reason, the credit bureaus want to know that you can handle this type of loan, so it’s in a separate category from credit-card or mortgage loans. And if you don’t have a recent installment loan, then your credit report shows a big question mark for this section.
If you’d rather lease than buy a car, a lease still counts as an installment loan as far as your credit is concerned. But if you’re not in the market for a car, there are other ways to get an installment loan on your credit report.
A jewelry loan will do the trick, as will a signature loan, which is a personal loan backed only by your signature and your promise to pay it back.
A signature loan can be for almost anything. I have a friend who helped a client get a signature loan from a bank, just so he could get an installment loan on his credit report. The client told the bank he wouldn’t even spend the money. The bank agreed to put the money in his account and make monthly withdrawals until the debt was repaid.
That’s one option. Another is to take out a loan on a car you already own. If you don’t need a new car, simply refinance the one you have.
Dale Clarke, a cash-flow specialist at my company, did exactly that. After checking his credit score, he discovered it to be well below 800 because he didn’t have a recent installment loan.
After refinancing his car, an installment loan appeared on Dale’s credit report. He was able to pay off the loan quickly, and his score jumped 30 points. This was possible for Dale because a person’s “credit mix” makes up 10 percent of the score. By improving his credit mix and showing he was responsible in the three main credit categories (installment loans, credit cards, and mortgages), Dale’s score got a boost.
It was also significant that Dale’s installment loan was recent. To get the best results, you want to have an installment loan within the last two years of your credit history—either one that you’re paying down now or one you’ve already paid off.
Accounting for all factors
It’s been reported that nearly 85 percent of consumers have errors on their credit report, so check yours regularly for misreported limits, duplicate accounts, and anything else that may be incorrect.
You can get a free report once a year from annualcreditreport.com. To get your credit reports and an accurate Next, it’s best to have three to five credit cards with the maximum limit that you can qualify for. Try to keep your balances low at all times—no higher than 30 percent of your limit, but the lower the better. And don’t cancel old cards. The length of the card’s credit history helps your score.
Finally, make sure to have an installment loan within the last two years of your credit history. That can be a car loan, a jewelry loan, a signature loan, or even a car lease. If you follow these steps, your efforts will go a long way toward maximizing your credit score.
Garrett B. Gunderson, a lifelong entrepreneur, is a financial advocate to chiropractors and engages in a vitalistic financial philosophy to assist DCs creating sustainable wealth. His company, Wealth Factory, helps entrepreneurs navigate personal finances and investing. He wrote the New York Times’ bestselling book Killing Sacred Cows. Get a signed hardcover copy at ebookforchiros.com.