How Budgeting Can Help You Improve Your Credit Score

How Budgeting Can Impact Your Credit

Making a budget and sticking to it can have an indirect positive impact on your credit in several ways. Budgeting can help you:

• Pay bills on time. Payment history is the most important factor in your credit scores. A late payment, and the resulting negative mark on your credit report, can do significant damage to your credit scores. Creditors typically report late payments to the credit bureaus (Experian, TransUnion and Equifax) once it's 30 days past the due date. Following a budget can help make sure you don't run out of money by the time bill payments are due and help you keep track of when bills are due.
• Reduce your reliance on credit. If you find yourself using credit cards to make up for a cash shortfall before your next paycheck, you could end up carrying a high balance on your cards. Overcharging increases your credit utilization, which contributes to your amounts owed—the second most important factor in your credit scores. Keeping your balance under 30% of your credit limit on each card helps avoid credit harm, but the lower, the better. Maintaining a budget can help you make sure there's enough money set aside to cover your bills, preventing you from swiping a credit card when there's not.
• Pay down your debt. If you already have debt, budgeting can help you cut it down. When you track expenses and limit what you spend in various categories, you can send more money to debt payments and make progress faster.

Learn more: What Affects Your Credit Scores?

Additional Benefits of Budgeting

Beyond helping boost your credit score, there are other perks to having a budget. It can help you:

• Reach financial goals faster. A budget is so much more than a plan to ensure you pay bills on time and avoid overspending. It's also a tool you can use to help reach financial goals faster, like saving for retirement or for a down payment on a home or car. When you budget with a specific goal in mind, it might help you stay inspired to follow your spending and saving plan for longer.
• Create an emergency fund. More than a third of U.S. households said they didn't have enough cash savings to cover an unplanned expense of $400, according to a 2024 Federal Reserve report. Budgeting makes it possible to build an emergency fund that can help protect you when the unexpected happens. You can budget the amount you want to save each month until your stash is fully funded with at least three to six months' worth of living expenses, the amount most experts recommend setting aside.
• Plan for retirement. Saving enough for retirement can be tough if you're only making contributions as a last step after covering other expenses. Use a budget to determine how much you can realistically save for retirement each month and make automatic contributions to hold yourself accountable.
• Stop living paycheck to paycheck. If you regularly run out of money before the next payday, a budget can help you get a handle on your expenses. You may find you need to make changes, like cutting back on certain expenses or earning more income, to achieve more financial security.

How to Make a Budget

When starting fresh with a new budget, determine how much money you have coming in and going out each month, choose a method that you're likely to adhere to, then set it up with intention and follow the plan.

Step 1: List Your Income

Start with income that you regularly receive each month. Calculate the amount you receive by adding up the net pay, or after-tax income, found on your pay stubs.

Next, jot down any income you receive that's irregular or changes each month. If your earnings fluctuate because you're an hourly employee or you're self-employed, average your earnings from the past three to six months. You can also use the minimum amount you expect to earn from this income source for your budget.

Step 2: Compute Your Expenses

Review your credit card and bank statements for the past three to six months. As you look through the transaction activity, note the expense type and amount, and create a category for it in your notebook or spreadsheet. Many financial institutions' online account portals automatically categorize expenses for you. Or you can use a budgeting app to connect your accounts and sort your expenses with less effort.

You may have categories for housing, food, utilities, insurance, debt payments, groceries, child care and pet supplies, just to name a few. For expenses that may vary from month to month, like groceries, gas and utility bills, use the highest possible cost when projecting expenses for upcoming months. If you don't end up spending that much, you can put the leftover money toward other things.

Step 3: Set Realistic Goals

Next, choose the amount you plan to spend in each category going forward. In order for your budget to work long term, it's vital that you set realistic goals for yourself. Impractical spending goals are more likely to go unmet, which can lead to a loss of motivation.

When you write down your goals, attach figures and decide how much it will cost to make them a reality. To illustrate, if you want to save up $2,400 in the next six months to put toward a new car, you need to add a line item for saving $400 each month in your budget.

Being realistic also means letting yourself have some fun. A carefully budgeted life doesn't have to be one without the occasional splurge—in fact, planning for impromptu spending and regular personal care can make it more likely you'll continue to budget and meet your financial goals.

Learn more: How to Set SMART Financial Goals

Step 5: Monitor Your Spending

After your first month with a budget, take a look at how your spending ultimately lined up with the plans you made. If it didn't, you may need to make adjustments to your budget goals, your spending or both. Ultimately, you want to keep close tabs on your spending to ensure your budget is realistic and won't be too challenging to follow going forward.

Learn more: How Often Should You Reevaluate Your Budget?

Step 4: Choose a Budgeting Method

Beyond the steps noted above, choosing a specific budgeting plan can guide your actions and help you adjust if your income or expenses change. The best budgeting method for you depends on your personality and the amount of time you want to devote to its maintenance. Here are some options:

• Pay yourself first: When you pay yourself first, you'll decide on an amount to save each month (for retirement, emergency savings and other goals) and transfer that amount into savings or retirement accounts before it can be used for other expenses. It's important to make sure you have enough in your checking account to cover your bills, but paying yourself first can get you into the habit of saving. It can also be a hands-off way of budgeting if you decide not to closely monitor where the money in your checking account goes—which can be OK as long as you continuously meet your saving and debt repayment goals.
• Zero-based budgeting: A zero-based budget is for those who want to know where every penny goes and who are willing to spend a fair amount of time monitoring their budget. You'll assign every dollar to a category, including savings and debt repayment, until your entire income has been allocated. That means you'll need to regularly track how much you're spending to ensure it's aligned to your plan.
• 50/30/20 method: The 50/30/20 budget plan suggests spending 50% or less of your after-tax income on essential expenses like housing, food and minimum debt payments; 30% or less on discretionary items like entertainment; and 20% or more on saving and paying off debt. It's a middle ground between giving every dollar a job (zero-based budgeting) and saving a certain amount in lieu of tracking spending by category (pay yourself first).
• Cash stuffing or envelope budgeting: Cash stuffing advocates creating envelopes for different budget categories, like gas and entertainment, and putting physical cash in each according to the amount you want to spend that month. It requires withdrawing a lot of cash and following a complicated system that isn't always aligned with the realities of everyday life, such as stores that only accept cards or the ease of online bill payments.

Learn more: Types of Budget Plans to Know About

Step 6: Stick to the Plan

Deciding on a plan is essential, but actually following it is what matters most. When you struggle to stay motivated, refer back to the financial goals you set when you began this process—whether it's improving your credit, paying off credit card debt or buying a house. Remember that changes like improving your credit score and building a retirement fund take time, so don't lose hope if you don't see results immediately.

The Bottom Line

By creating a budget and sticking to it, you can achieve your financial goals and possibly see improvements to your credit. Budgeting can also help you build an emergency fund, plan for retirement and have more flexibility in your spending between paychecks. Consider signing up for free credit monitoring through Experian, which can help you track your credit score and overall credit health as you start the process to budget and improve your financial well-being.