7 Building Blocks of Good Credit

Does improving your credit score seem daunting? It doesn't have to be. Taking a few small steps now can mean the difference between a 550 and a 780. Follow these tips to see your score improve.

1. Request a copy of your credit report

You're entitled to a free credit report each year from each of the nationwide consumer credit bureaus -- Experian, Equifax and TransUnion -- thanks to the Fair Credit Reporting Act.

"It is important to remember that consumers have more than one credit report. Since there are three different credit reporting agencies, the information on each of their credit files may differ," says Clifton M. O'Neal, senior director of corporate communications for TransUnion. Requesting a free credit report "can help consumers keep tabs on all of their financial activities."

O'Neal advises checking each report for fraudulent activity and correcting any errors that appear. Each credit bureau's Web site has information on how to fix errors.

2. Take steps to improve your credit score

The credit bureaus and other companies track the information contained in your credit report, and crunch them into a three-digit number called a credit score.  Having a low credit score will raise a red flag for lenders and could lead to having a loan application rejected. Or even if the application is accepted, your interest rate could be much higher. In other words, if you want to buy a house or a car, improving your credit score is an essential first step.

"If you are going to be applying for credit at any point in the future -- whether a new credit card, a mortgage, a home equity line of credit or a small business loan -- your credit score will largely determine how little or much you are going to have to pay for that credit ... if you get it at all," says Russell Wild, certified financial adviser and co-author of "One Year to An Organized Financial Life."

You can improve your credit score by paying bills on time, keeping your debt below 35% of your available credit, paying down debt and disputing errors on your credit report.

3. Read (and understand) the terms and conditions of your credit card contract

No one wants to read the fine print, but it contains all the important information about payment terms, interest rates, annual fees and penalties.Your credit card contract -- also called a card agreement or "terms and conditions" -- lays it out, though it often takes strong eyes and college-level reading comprehension.

"Most people don't bother reading the terms and conditions, and that's a mistake," says David Jones, president of Association of Independent Consumer Credit Counseling Agencies (AICCCA). "You shouldn't be surprised when your interest rate goes up because you missed a payment. It's all there in black and white."

Most credit card agreements are hard to understand, but that could change: As part of the 2010 Wall Street Reform and Consumer Protection Act, a new Consumer Financial Protection Bureau will have the power to mandate changes in contracts to make them easier to understand.

4. Read your monthly statements carefully

According to Jones, credit card statements are easier to understand than ever. The Credit CARD Act of 2009, whose major provisions took effect in February 2010, required new design and disclosure requirements to make statements more reader-friendly. Among the requirements, the fees for making late payments and how much is being paid in fees and interest on different types of accounts must be shown. CreditCards.com has put together an interactive look at the new credit card statements, using examples from all the major card issuers.

If there's something that doesn't make sense, call your credit card company or a credit counseling agency accredited by the AICCCA or the National Foundation for Credit Counseling to ask questions.

5. Pay down -- or pay off -- your credit card balance

"As soon as the January bills come in and cardholders realize how long it's going to take them to pay off their holiday spending, paying down credit card bills becomes a priority," Jones says.

One of the changes mandated by the CARD Act was that card statements must show how long it will take to pay off a balance if you pay only the minimum.

When it comes to paying off credit card balances, avoid making new charges, focus on paying off the card with the highest interest rates first and always pay more than the minimum payment.

"Even if you can only pay $5 over the minimum balance, it's a good idea because it goes straight to the principal and helps reduce your debt, even a little," says Jones.

The CreditCards.com calculators will help you customize a credit card payment plan and see the true cost of paying just the minimum.

6. Use credit cards that match your spending habits

Choosing the "right" card at the checkout can save you a bundle, according to Wild.

Consider the payment terms, he says, "most notably the interest rate you'll pay if you don't pay off your debt at the end of the month."

Cardholders who don't pay off their balances at the end of the month should be willing to sacrifice rewards to get a card that has a lower interest rate.

Wild also suggests using caution with store cards, especially those promising zero interest. If you have a history of late payments, interest rates can skyrocket which is an expensive mistake.

Annual fees can also add up. If you're paying $50 per year on several airline rewards cards but have never cashed in a single air mile, those accounts might not be the best fit for your spending habits.

7. Think twice before canceling cards

Your credit score is determined, in part, by the variety of accounts you have, and whether you have eaten up a lot of your available credit by carrying balances. In other words, outstanding balances on multiple cards will affect your credit score. Wisely manage those balances and don't be in a hurry to close out accounts.

"Any major changes in your credit habits, including canceling cards, will throw up a red flag and impact your credit score," says Jones. "If you want to reduce the number of cards you carry, cancel one card and a few months later cancel another instead of canceling them all at once."

Having multiple lines of credit and low balances gives you a low credit utilization ratio, which is good for your credit score. Be sure to keep your balances low -- overall, and on each credit card you have. And use each card every so often so the credit card company doesn't cancel the account.

If you're struggling with debt and having too much available credit may lead to the temptation to spend, you might be better off canceling those credit cards. It's better to let your credit score take a hit for closing accounts than to face the consequences of charging too much debt and not being able to pay it off.

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