7 Steps to Perfect Credit

By Michael Cramton
March 30, 2011

You don’t have to be a millionaire to have good credit -- there’s no income-level prerequisite for a 750-plus rating. It’s simply a matter of paying your bills on time, being in good standing with your existing debt and not maxing out the lines of credit you do have.

In fact, the majority of your FICO score isn’t based on income at all. 30% of your rating is based on the percentage of existing debt on revolving accounts compared to the amount of available credit. And what's easier, if you pay your bills on time with no major delinquencies (later than 90 days), that's another 30% of your score right there.

The similarities between people with good credit aren’t that they all make piles of money. On the contrary, the commonalities among these folks are that they pay their bills on time; they have up to six revolving credit accounts in good standing (credit cards); they have a mortgage or auto loan; and their debt levels on open accounts are less than 35% of their total credit limit.

So if you’re shopping for a big-ticket item, your credit score is the key to the best interest rate possible. When saving for a house, buying a new flat panel on credit or buying your dream car, the interest rate can make a difference in your monthly payment.

Here’s what's considered when determining your credit score:

  • 35 percent -- A history of on-time payments to credit accounts
  • 30 percent -- The total amount of debt compared to available credit
  • 15 percent -- History of open credit lines; the longer your credit history, the better
  • 10 percent -- Number of applications for new lines of credit
  • 10 percent -- Considers the types of credit lines: credit cards, auto loans, mortgage, etc.

The steps to having good credit are really quite simple. And in as little as three months you can see a marked improvement in your score. Here’s how it's done:

Step 1. Obtain a free copy of your credit score from annualcreditreport.com. Review the info and make sure everything is correct and accurate. Is your address current? Are the existing accounts correct? Are there any closed accounts listed as still open? Are there any accounts you've forgotten about? Also, be sure to review your history and see if there are any negative instances of late payments or delinquent activity, just to give you an idea of what you’re up against.

Step 2. Be in good standing with existing accounts. If you’re continuously late on payments or behind on a loan, your first priority is to get these accounts up to snuff. Contact any accounts on which you are delinquent and work with them on getting back onto firm ground. More than likely, they’ll be willing to work with you. But you have to be big enough to reach out and accept your wrongful past. 

Step 3. Decrease your debt. This is the hardest part. You have to take a cold, hard look at your financial situation and map out a game plan for digging yourself out of any holes. Of your existing accounts, what has the highest interest rate? Are there any fast-cash loans that need to be eliminated? Review your credit card debt and create a plan for paying it down. The best method is to attack them one at a time with a large payment month after month until they’re gone, starting with the highest interest rates. Remember, your debt levels need to be less than 35% of your available credit, though the lower that percentage the better.

Step 4. Make your payments on time. As you work out a plan to pay down your existing debt, it's also important to pay your utility bills and credit card payments on or before their due date. Create a calendar of when bills are due and make a point of paying them before that time. If this might mean making an extra payment to a credit card before your big payment, so be it. You can always deduct that minimum payment from your big-boy payment, or let it stand and pay off your balance that much faster.

Step 5. Control your spending. As you work towards decreasing your debt, it's important not to add to the heap. Don’t buy anything unless you can pay for it in cash. If you must shop, go online or to the mall and make a list of what you will treat yourself to once you’ve decreased your debt. If you’re thinking of a new car, go to the CarMax (NYSE: KMX) lot and test drive as much as you like -- but don’t give into the temptation to buy. Is a new flat panel TV in your future? Head over to Best Buy (NYSE: BBY) and shop for the best features. Once you’ve paid down your debt, you’ll be getting a better interest rate on this purchase, anyway. And the motivational aspect of this reward might just see you through your darkest hours.

#-ad_banner_2-# Step 6. Don’t apply for new credit. Multiple credit inquiries can hurt your credit score. Granted, there's a two-week window where multiple credit inquiries are acceptable (for when consumers are shopping for the best interest rate on a mortgage, for example). But just to be on the safe side, save these credit inquiries for when you’re ready to buy.

Step 7. Consider your history. Don’t close old accounts, just decrease the credit limit. 15% of your credit score is comprised by the length of your credit history. Don’t worry if not all of that past is pretty; your recent activity will have precedence (so be sure to hammer home Tip #4). And if you’re paying all of your bills on schedule, it’s just a matter of time before any dings fall off the map. If you don’t have a good mix of credit (credit cards and a mortgage or auto loan), it may be time to take the plunge on an item that will diversify your credit. Once you’ve gotten your FICO where you want it, your possible big-ticket purchase will help your future credit score -- just be sure to make those payments on time.

If you’re way over your head in debt and your monthly income is far less than what’s required to get on top of your debt payments, you may need the assistance of a debt management company to simplify your repayment procedure. Once you’ve worked out a system to take control of your debt, you’ll be on the path to an improved credit score. Have patience; once the bad history falls off in a few years, there’s no stopping you from obtaining a perfect credit score -- and treating yourself to that flat panel you’ve been waiting for.