There is a lot of misinformation floating around on the internet about your credit score: whether you need one, what a bad score can cost you, and even how to fix it. The short answer is that you need a good credit score, even if you don’t often borrow money, and fixing your credit score it is not an overnight matter. Luckily, there are five easy steps that can take you from credit poor to creditworthy.
Why You Need A Good Credit Score
Why do you even need a good credit score anyway, especially if you never borrow money and are against debt? Because your credit score is used for more than just determining your interest rate on a loan. Employers use it to determine if you are trustworthy and reliable since a good score means you live within your means and pay your debts as agreed. If you are in a position of trust with your employer and have a security clearance, a very negative change in your credit score can put you at risk of losing your clearance and potentially your job. When shopping for a place to live, landlords will run your credit to see how reliable you are at paying as agreed and on time and a bad score might cost you the apartment of your dreams. Cell phone, cable, and utility companies also may rely on your score to determine if they should take you on as a customer and a bad credit score might mean that you will be required to put down a deposit before they will connect your cable.
What Does Bad Credit Cost You?
Your credit score determines not only if a lender will agree to do business with you, but what interest rate you will pay for the money you borrow. The difference between a poor score and an excellent score will literally cost you more cash. The lower your score, the higher your interest rate, and the higher your monthly payments, resulting in a higher overall cost for borrowing in the first place. You can use an online loan savings calculator to show just how much more you will pay on a loan for one credit score over another.
For a $200,000, 30-year mortgage, check out the numbers below. For this mortgage, the difference between a low credit score of 625 and a high score of 765 is $6,653 more each year that the person with the low credit score will pay for the same loan.
This same principle applies to car loans, personal loans, and any other type of loan product. According to Bankrate.com, the average monthly payment on a new car loan in Q4 2018 was $545 with a borrowed amount of $31,722 and an average rate of 4.75%. For a used vehicle, the average payment was $387 for a prime borrower with below-average risk and an average loan amount of $20,077. Super prime borrowers (with rates of 661 and up) financing a new vehicle will pay a little less. If that’s you, and you’re financing a $30,000 loan for 72 months at a rate of 4.19%, expect your monthly payment to be about $472. Deep subprime borrowers (with rates of 600 and below) can expect to pay around $632, or $160 more per month, for the same loan. And it will cost them a staggering $11,552 more in interest over the life of the loan.
So How Do You Fix Your Credit Score?
Well, I’m glad you asked. Your credit score is made up of a variety of factors, so there is no single magic bullet that can change your score. Rather, focus on a holistic approach to improve your score by improving all parts that factor into the score.
- Pay Your Bills On Time
Since your payment history is the largest component of your credit score, it is best to start there. Make sure that you pay all your bills on time, every time. Setting up easy electronic payments from your checking account ensures you won’t forget to make a payment. If you have to mail in a payment, pay it early so the check has plenty of time to arrive in the mail. Whether payment was late and just how late it was is reported on your credit report and a lot of late payments can really drag your score down. The good thing is that some of your creditors, including many mortgage companies, will offer a grace period of up to 15 days where they won’t report the payment as late to credit bureaus. Not all companies do this so check with your creditors so you know their grace period policies.
- Monitor and Dispute Incorrect Reporting
Keeping a close eye on your credit report will allow you to monitor whether there are any inaccuracies in your report. You can pull free copies of your credit reports from annualcreditreport.com once a year or you can sign up for a free credit monitoring company like Credit Karma. If you see any accounts in collections or loans that you are unfamiliar with, or inaccurately reported late or missed payments, contact those creditors to set the records straight. If you request it in writing, a creditor must provide you paperwork verifying your responsibility for a charge or loan within 30 days or remove it from your report. Cleaning up inaccuracies can remove negative reporting that drags down your score and can also help spot and stop fraud.
- Never Cross the 50% Rule
Your available credit is the second-largest component that factors into your score, so be careful to not cross the 50% rule. That is, don’t use more than half of your available revolving credit. Keeping balances on your credit cards in excess of half your available credit not only racks up interest charges but also lowers your score. Being a responsible credit user means that you don’t use all of the credit that you have, rather you effectively manage the credit you have. And if you don’t have any revolving credit or even any open loans reporting on your credit report, consider taking out a credit card (even a secured one) that you can responsibly use for a few small purchases and pay off each month to give you some available credit and a positively reporting payment history.
- Don’t Close Old Accounts
Your length of credit history is the third-largest factor to calculate your score, so make sure that you keep those old cards open, even if you don’t use them. Most loans will close when you pay them off, but revolving credit like a credit card or line of credit will stay open even if you don’t use it for a while. Keep these accounts active by occasionally charging something to them and then paying it right away, but you can leave the cards at home and ignore them. Just let them sit and report to the credit bureaus that you have had a long and beneficial relationship with that bank or credit card and watch it boost your score.
- Be Selective When Shopping For Credit
Too many frequent inquiries on your credit report or many newly opened accounts will ding your credit. That doesn’t mean that you can’t shop around to see what lender will offer you the best rate on a car loan, but it does mean that you should be selective in who you ask to do a ‘hard pull’ on your credit. A hard pull means that the creditor will run all your information to attempt to extend credit to you as an active part of the application process. If you are shopping around for a loan, keep it to a small handful of creditors (max of 3) that pull your credit to provide you with a quote, and keep them all in the same small time frame. Three creditors making a hard pull within 3 weeks shows you are shopping for a loan for a particular purchase. Conversely, having 10 creditors making card pulls every month or two shows you are regularly shopping for more credit and may signal that you are a credit over-user and will lower your score.
You don’t have to be perfect or have perfect credit to understand the importance of your credit score and how it is calculated. Understanding how your credit score is built and what positively and negatively contributes to it can inform the choices you make concerning your finances. These five simple steps can help improve your credit over the long term, but there is nothing that can raise your score 100 points in a weekend. Anyone that promises you that is a conman. Instead, small, consistent actions will give you that consistent positive reporting that contributes to a good score. Working with your financial advisor can help you determine a more personalized approach to fixing your credit and working to meet your long term financial goals.
