Credit scores are essential, and that’s a fact. Your credit score and report are ways of keeping track of and evaluating how you use credit and, to lenders, your creditworthiness. But what steps can you take to improve your credit score to avoid the worry of credit and loan rejections?
Often overlooked, the first step to improve your credit is to start budgeting. A budget can help you rebuild your credit and assist you in refining your overall financial health. Let’s learn more.
What is a Credit Score?
A credit score is a three-digit number, typically ranging from 300 to 900, that gives your lender or creditor a snapshot of your credit report and an idea of how financially responsible you are. Your credit score is calculated using the following information from your credit report:
Payment History (35%)
Any lender or creditor wants to know if you’ve paid your past credit accounts on-time, which is why payment history is an essential factor in calculating your credit score. There’s always time to build a good history and improving your credit score by ensuring you never miss a payment.
Amounts Owed (30%)
When it comes to your credit score, having credit accounts that you currently owe money doesn’t mean you’re not creditworthy. Lenders generally don’t like to see someone using a lot or the majority of their available credit. This is your credit utilization ratio.
If you have a credit limit of $5000 and have used $4750, your lenders may consider you overextended and believe you may be a risk of defaulting on payments. Try keeping your credit utilization below 30% of your total credit limit. This will help you improve your credit score.
Length of Credit History (15%)
A longer, good credit history will work in your favour when it comes to your credit score.
New Credit (10%)
It’s best to avoid opening multiple credit accounts within a short period. This may worry your lenders as they may consider you a greater risk because of this.
Types of Credit (10%)
This is your credit mix – credit cards, retail accounts, installment loans etc. Some lenders may like to see a mixture of different types of credit on your report.
Good Credit Score vs. Bad Credit Score?
As mentioned previously, a credit score is calculated using a mixture of components, including payment history, amounts owed, length of history and more. If you pay your debts on-time and ensure you’re not over-utilizing your credit limit, you are on your way to improving your credit score.
It’s important to remember your credit score may vary depending on where you check it. They vary due to the scoring models, credit data and algorithms that each credit score agency uses. These scores all have the same goal: to predict a consumer’s likelihood to pay their bills. Thus, it was discovered among many Canadians that their credit score was inconsistent across free credit score software and compared to credit bureaus such as TransUnion & Equifax. So, depending on where your credit score may slightly differ.
Regardless of where you check your credit score, if you practice good habits, your score should be positive, and you should be on your way to improving your score. When comparing a good credit score and a bad credit score, it’s easy to see the benefits. A good credit score will allow you to obtain almost any financial product you want at a reasonable interest rate. In comparison, a bad credit score will give you the opposite results.
Whereas you may get a loan with a bad credit score, your options are quite limited. You won’t have the opportunity to shop around with different lenders, exploring various providers and finding the best interest rates. Usually, when your credit score is bad, you may have to resort to an alternative lender who charges higher rates due to the increased risk of lending to someone with a poor credit history. The best way to avoid this is to improve your credit score.
How Can Budgeting Improve Your Credit Score?
When searching for ways to improve your credit score, creating a budget and sticking to it can make a huge difference. Following a budget can help make sure you don’t run out of money by the time bill payments are due, ensuring you don’t have a missed or late payment. A budget will also help you avoid tapping into that credit card and over-spending every month, which keeps your credit utilization ratio low.
We all know that budgeting can help us save for that much-needed vacation, a new car, a mortgage down payment and more. But budgeting can also help us pay down debt faster. If you’ve built up large amounts of debt, whether it’s from loans or credit cards, budgeting will help you reduce and eventually eliminate debt with the right techniques. In time, adapting good budgeting habits will help you improve your credit score.
How to Create a Budget?
If you’re new to budgeting or trying to figure out a way to improve your score, there are many ways to get back on track. Let’s see how you can get started:
Step 1: List Your Income
Firstly, write down the income you regularly receive each month. If you’re paid bi-weekly or semi-monthly, you can check your pay stubs and combined the net pay on the bottom of your two payslips.
Next, you should calculate the income you receive irregularly each month or a payment that changes occasionally. You can use the minimum amount you earn from this for your budget. It’s better to under-budget than to over-budget.
Step 2: Calculate Your Expenses
When trying to budget, it’s essential to be aware of every bill you need to pay to budget effectively. Review your credit card and bank statements from the past three to six months to figure out the patterns of what you pay and when. While looking through your transaction history, take note of any other expenses too, such as food, utilities, childcare, pet supplies, to name just a few. You can then estimate on average how much you pay and incorporate it into your budget.
Step 3: Set Realistic & Achievable Goals
When budgeting, it can help to set realistic and achievable goals to motivate you to stay on track. Having a goal in mind you feel you can reach will help you resist the temptation to overspend or get off track.
Financial goals are individual, and all vary depending on the person. For example, you may have a huge loan you want to pay-off. Make this your goal when setting out your budget and write out where you’d like to be in six months’ time. Or maybe you want to save for a car. Write down your goals whatever they are, as visualization can help motivate you too.
Being realistic also means allowing yourself to have some fun. A carefully budgeted life doesn’t have to be one without the occasional shopping trip or spending splurge. In fact, planning for some out-of-the-blue spending can reduce the anxiety that might accompany starting a budget.
Step 4: Track Your Spending
After your first month with a budget, take a step back and look at how you’ve been doing. Have you been overspending on your groceries? Did you miss a couple of payments on your credit card? Make sure you review your spending by checking your bank and credit card statements.
If you haven’t been following your budget, there’s more than likely a reason why. Maybe you weren’t realistic and set too-strict guidelines for yourself. You can always adjust your budget monthly to ensure you’re working toward your goals.
Step 5: Consistency is Key!
This is a crucial step to remember. One month of budgeting usually won’t mean your goals have been met. If you struggle to stay motivated, check back in with yourself and remind yourself why you’re budgeting in the first place.
Remember that you need to improve your credit score for that mortgage for the house of your dreams? Or that vacation you need? Well, that’s why you’re budgeting! Sticking to the plan is essential, and what matters the most.