Living with bad credit is certainly tough because it makes almost everything more difficult and expensive. Imagine owing a car, for example. If you have a bad credit score, the insurance company may as well charge you a higher interest rate just because of your poor credit score. Want to purchase new utilities for your home? The company may ask you to pay a security deposit if your credit is not shiny. Of course, there are opportunities to get a loan without a credit check. But the list of companies that actually do check your credit card to give you a loan, credit card, or sell you an expensive item is quite long – and, is getting longer by the minute.
Repairing bad credit takes time. No matter what you may hear or read, there is no easy and quick way to fix a FICO score and improve your credit worthiness. So, the best thing you can do is focus on rebuilding your credit by repairing your credit history first. Here is how.
How are FICO Scores Calculated?
Data (both positive and negative information in your credit report) from five categories is used to calculate your FICO Score. Each category is given a percentage, depending on its importance. Lenders also look at several other things, such as how long you have worked at your current job, your income, and the kind of credit you ask for. For the general population*, FICO Scores are calculated based on:
Payment history (35%) – Whether you have been making payments on time is one of the most critical factors in a FICO Score.
Amounts owned (30%) – It is okay to owe money on your credit accounts. What matters is if you have used a high percentage of your available credit (see credit utilization ratio below); it may be an indicator that you are probably going to be missing or making late payments.
Length of credit history (15%) – FICO Scores usually increase with a longer credit history. However, if you don’t have that, your FICO Scores may still be high if the rest of the credit report looks good. What lenders look into are the age of your oldest and newest account and how long its has been since you have established and used certain credit accounts. You may use an online calculator to calculate the average age of your accounts.
Credit mix in use (10%) – This factor can only play a key role in finding out your FICO Scores only if your credit report does not have enough information to base a score on. Your credit cards, mortgage loans, finance company accounts, instalment loans and retail accounts are all taken into consideration by FICO Scores. You don’t need to have them all. What is most important is to have credit accounts with a good credit history. So, if you don’t intend to use a credit account, it is best not to open it. Let’s also note that people that have managed their credit cards responsibly are viewed as a lower risk than those that don’t have credit cards.
New credit (10%) – If you don’t have a long credit history, it is best to avoid opening several credit accounts in a short period of time.
*The importance of these categories may vary per credit profile. For some consumers, one factor may play a more crucial role in determining their FICO Scores than for a person with a much different credit history. For instance, people with a longer credit history will be factored differently than individuals who haven’t been using credit long. This is why it is important to look at one’s entire report to calculate their credit score.
How to Get Started
There are three things you can do right now:
Check your credit report
As a consumer, you are allowed one copy of your credit report every year (it is free of charge) from TransUnion, Experian, and Equifax – the three major credit reporting bureaus. Require yours and look for errors. You will be surprised by how many Americans complain about errors in their credit report. Make sure all payments are correctly listed and that the amounts owned to each of your open accounts are correct. If you spot any errors, dispute them with the credit bureau that provided the report.
Note: Requesting and checking your credit report won’t affect your score provided you order the report from the credit reporting agency directly. Also, according to Equifax, there are two types of inquiries you could request for (1) soft inquiries and (2) hard inquiries (when you review your credit history after you have applied for a new credit card or loan). Of the two, hard inquiries remain on your credit report for 2 years and are visible to both you and the potential lender. This does affect your credit score.
Set up reminders
It is extremely important to make your credit payments on time. Setting up payment reminders can save you from a lot of stress and trouble. There are several apps you can use, for both Android and iOs devices while payment reminders are also offered by some banks too. To make things easier, you can consider enrolling in automatic online payments which will help you consistently pay your bills on time.
Reduce your debt
Start by stop using your credit cards if possible. Then, make a list of every single account you have and determine the amount you owe to each one. Also, check the interest rate your accounts are charging you. To help you gather all necessary information, you may check your credit report’s recent statements or go online. Once you have everything figured out, come up with a payment plan. The idea is to reduce the debt of your cards with the highest interest rate first and just maintain minimum payments on all other accounts.
- Personal finance experts recommend using what is known as the credit utilization ratio (CUR), which is the percentage of your available credit. A CUR less than 30% is usually considered good as it means that you are using less than 30% of the total credit available to you. To accomplish that, try to keep your balances below 30% of your credit limit. To calculate that ratio, divide the balance of a credit card by the credit limit. Then multiply that number by 100 to get a percentage.
- It may take a while before you build your scores back up because collections stay on your credit report for seven years, even when a collection account is paid off. However, lenders do see a collection account that has been fully paid more favorably than if left unpaid.
Fixing Your Credit Score
Work on your Payment History
Past problems with late or missed payments cannot be fixed easily. What you CAN do, though, is make things different from now on. For example, paying your bills on time will improve your FICO Scores. And, the longer you are punctual with these payments, the more your FICO Scores will increase as your actions will indicate that you are managing your credit well. Now, if you find it very difficult to make those payments, it is advised to see a legitimate credit counselor or contact your creditors to get some help. The point is to begin to manage your credit again, so feel free to use any means available to help you achieve that.
Handle The Amounts You Owe
Cleaning up the amounts you owe is easier than fixing your payment history. However, you do need to be disciplined (financially) if you want to succeed. Start by paying down revolving debt rather than moving it around. If you are considering to close unused credit cards to raise your scores, you may need to reconsider. Closing a credit card, especially your oldest one, can lead to a significant drop in your credit score. There is also no point in opening new credit cards that you don’t intend to use to increase your credit, as it lowers your average credit age. Plus, when you open a new credit card, an inquiry is placed on your credit report, even if you eventually decide not to accept the credit card or are not approved.
Leave Old Debt on Your Report
Having old debt that is paid as agreed and handled well is good for your credit. So, leave good accounts and old debt on as long as possible because the longer your history of good debt is, the more your score improves.
- Bear in mind that opening new accounts or rapid account buildup will lower your average account age, which will negatively affect your scores. So, refrain from opening a lot of new accounts quickly if you have been managing credit for a short time.
- If you plan to make a big purchase some time in the near future, make sure you order your credit report, at least, 3 months before you apply for credit.
- Don’t search for multiple loans simultaneously. If you need a loan, try not to search for many credit lines. FICO Scores can distinguish such searches from searches for a single loan.
Repairing/improving a credit score is more about fixing any errors in your credit history and then maintaining a good credit history for as long as possible. If you follow the guidelines above, chances are you will be able to raise your scores, at least, 100 points in the following months. Arm yourself with patience and discipline and you will get there shortly!