If you want to make a big purchase, your credit score is extremely relevant.
For example, maybe you are ready to sell your old car and get a new one, or even buy a house. These big purchases are unlikely to be fully cashed for you. Instead, you can get a loan.
A lender will want to see that you are likely to pay off that loan on time and as agreed.
One of their best indicators, because they determine whether or not you are a good borrower, will be your credit rating and credit history.
Unfortunately, if you don’t have a great deal of credit history or have negative items on your report, it can keep you from making big purchases and potentially moving your life forward.
Below is a guide to what you need to know to build or replenish your credit in a manageable and efficient way, regardless of your current financial situation.
What is a credit score?
Your credit score is a three-digit number that lenders and other third parties use to determine how risky it would be to lend you money. Credit companies, banks, and other financial institutions use your score to gauge how likely you are to pay off debt. If you have a higher credit score, it shows that you are in a stronger financial position and that you have a history of behavior that makes you more confident to lend to.
The most commonly used credit scoring system in the United States is the FICO score. The major credit bureaus use FICO scores to determine creditworthiness.
Your FICO score can vary between 300 and 850. Bad credit is anyone with a FICO score below 580.
Fair credit is generally considered a score between 580 and 669, and good credit is between 670 and 739.
A very good credit score is between 740 and 799. Excellent credit is over 800.
You don’t have just one credit score, which is surprising to a lot of people. Instead, your credit score can vary depending on the company providing it and the data the company uses in its calculation.
The impact of your credit score
The first way your credit score affects you financially is that it is used to determine whether or not you are approved for something like a credit card or a loan in the first place. The second way this affects you is by helping lenders determine the interest rate you will pay if you are approved.
The higher your FICO score, the more likely you are to be approved and the lower your interest rate should be.
With a low FICO score, even if you are approved, you can have a very high interest rate.
Calculating your credit score
Before you can start rebuilding credit, you need to have an idea of how your score is calculated. This will help you see where to focus your efforts.
Here are the main factors used to calculate your credit score.
The most important part of calculating your credit score is your on-time payment history. Your payment history is what shows a potential lender that you are reliable and that you will make payments to them on time.
You are penalized when you don’t pay on time. If you have a history of late or missed payments, a lender might think you’re going to have the same problem with them.
If you want to get a loan, having a solid repayment history is essential.
Even being a little late on a payment can hurt your credit score. The impact of late payments depends on how late you are. These late payments can be divided into categories of 30 days and 60 days, for example.
It could be an accident if you missed a payment just because you forgot, but it can dramatically and negatively affect your score. It doesn’t have to be a big payment to significantly reduce your credit.
How much debt you have
In calculating your credit score, it takes into account how much debt you currently owe and how it is distributed.
However, having a lot of debt does not inherently mean a lower credit rating. You could have a lot of debt, but still make your payments on time. It would show that you can easily manage your financial obligations.
Use of credit
The use of credit is another important factor that affects your credit score. It can also be described as your debt ratio.
Basically this is a measure of the total amount you have in your credit card accounts versus your limit on each. The lower your credit usage, the better. It will negatively affect your credit score if you maximize all the credit you have available, even if you make your payments on time.
Length of credit history
It is good to have old accounts on your credit report. When you have a longer credit history, it more fully shows your creditworthiness. The older your accounts and credit history, the better.
If you have a card that you no longer use, don’t cancel it. You have to think about how this will affect the the average age of your credit history.
The types of credit you have
While not as important as the above factors, calculating your credit score also takes into account the types of credit or debt you are using. Lenders often want to see a good mix of installment loans like a car loan, revolving credit like a credit card, and consumer finance.
When someone pulls your credit report, it can be a difficult investigation. Inquiries are the number of times lenders have requested your data. The higher the number of concrete requests, the lower your score can be.
Steps to improve your credit
You may have bad credit, or you might not have any credit. Either way, there are things you can start doing right now to improve the situation, especially if you are planning on making a big purchase in the near future.
Check for errors
The first thing to do is to make sure that your credit report is free of errors. You should do this every few months. People are often surprised at how often errors appear on credit reports.
Each year, you are entitled to a free copy of your credit report from each of the three major credit bureaus. Take advantage and read the information carefully. Make sure there aren’t any amounts, addresses, or accounts you don’t recognize.
If there is, open a dispute with the credit bureau to remove it.
Pay on time
For some people, being disorganized and having too many accounts is the problem. Create a simple spreadsheet or a way to keep track of all your payments and their due dates so you don’t inadvertently fall behind.
If you already have invoices in collection, prioritize the payment of currently open accounts.
Debt collectors can be a hassle, but staying up to date on your open accounts should be your top priority if you want to improve your credit.
Keep your credit available
Credit usage is, again, the percentage of your credit limit that you use. In addition to paying on time, it is extremely important to keep this level low. You should aim to not spend more than 30% of any card’s limit. The lower you can keep this percentage, the better.
A good strategy is to focus on reducing your highest balances first and worrying about others later.
The advantage of reducing your credit usage is that you quickly see the benefits.
Plus, you are not hurt by high credit usage in the past, as long as it is currently low.
Get a secured credit card
If your problem isn’t necessarily that you have bad credit or need to pay off balances, but rather your credit history is limited, a secured credit card may be a good option.
You can also get a secure card if your previous accounts have been closed and you want to start from scratch.
A secured card requires an initial deposit which is usually your credit limit.
Make sure that if you choose a secure card, you find one that reports your payments to the three major credit bureaus.
Another option for building credit is a home equity loan or a secured loan. Community banks and credit unions often offer these products. You would show proof of income and then deposit a down payment. The lender will keep this money while you repay it. Once you have paid off the loan in full, your money will be returned to you.
Finally, if you cannot access credit, another option would be to have someone co-sign for you. This is a huge favor, however, because if you ended up not paying the loan, then the cosigner credit would be affected as if they had personally taken it out.
Susan Melony’s Story