Your credit report is a financial report card. It tells lenders how likely they are to receive payments from you if they were to lend you money. Someone who has no credit history or a poor credit history will have more trouble getting approved for a loan then someone who has an exceptional credit history. Being an “at-risk” borrower will also cost you more money, as your interest rate will be higher since the lender is assuming greater risk.
And a delinquency you make today could come back to haunt you for years to come. Believe me, I know from first hand experience. After I graduated from college, my student loan repayment plan kicked in and bills started delivering to my parent’s house, unbeknownst to me. I, of course, had moved far away from home and had no idea I was supposed to start repaying my loans. Several years later when I went to purchase my first house mortgage lenders asked, “What happened here?” Sure enough, that slip-up was still on my credit report.
Your creditability with lenders is something you always want to keep in good standing. If this is something that needs improvement, you will want to keep. It is possible to improve your credit, and it is much easier when you know how your creditworthiness is determined. Unfortunately though, there are no overnight fixes for your credit score. Creditors look primarily at the last 12 - 18 months of your credit activity, and beyond. Improving your credit will require work, and in some cases a lot of work.
There are three major consumer credit reporting agencies, Experian, Tans Union and Equifax. These are the companies that monitor and report your repayment history, open accounts and credit applications. They examine these activities and assign a credit score to your name, otherwise know as the Fair Isaac Company score (FICO).
A FICO score ranges from 300 to 850, the greater the number the better. A credit score in the mid to high 700′s is a good score. It is unlikely that more improvement will get a better loan at this stage. Anyone below a 723 (the median score) can benefit from using some credit repair strategies.
All three of these companies have slightly different formulas for determining your credit score. The specifics on how they compute your FICO score is not public knowledge, but there is a general understanding on what they are looking for.
Debt-to-Credit Ratio: What you currently owe and how much you are extending your credit has about a 30% effect on your credit score. This is the quickest way to ruin or improve your credit. If you start nearing 40% of your available credit, then you become a risk factor to lenders. For example, if you have $10,000 in available credit and you have $5,000 in outstanding balances, that’s a sign of risk.
Solution: If you are maxing out your credit cards, the easiest way to improve your credit score is to reduce your debt-to-credit ratio. Get this ratio below 40%, but preferably in the 25% range. The obvious way to do this is to pay down your debts, but asking your credit card issuers to raise your credit limit will also help.
You will also want to maintain a 40% or less debt-to-credit ratio on each credit card you have. Just because you have $0 on a $5,000 available credit card but have maxed out another doesn’t put you in the clear. This is another sign or risk to creditors.
Credit History/Activity: A history with creditors has the largest weight on your credit score - around 35%. Having a clean credit history is the most important thing you can do to have a good credit score, since this makes up more than a third of your FICO score. Creditors want to see a history of loans and your ability to repay those loans.
Solution: Pay your bills on time. If you have a bad history, start making changes in your behaviors now to improve those blemishes on your report. This will take a long time to improve, but it is the most important aspect.
The second piece creditors are looking for is a long history of good credit. Having multiple new accounts will reduce your credit score, while long-standing accounts are good. If you are paying down credit cards to close the accounts, be sure to close the youngest cards first and hang onto the credit cards you have owned the longest. Closing older accounts can actually hurt your credit score, while closing new ones can improve your credit. Likewise, a static credit card that you never use is not helping your score. You are actually better off to use these credit cards to produce some activity, otherwise close them.
Credit Requests: Applying for and opening several lines of credit in a short period of time is a red flag for creditors. If you constantly transfer credit card balances to new cards as you chase the best rates, this could actually be costing you more money down the road when you need an auto or mortgage loan.
The number of inquiries lenders make to credit agencies asking about your credit can also negatively affect your credit. Too many requests from lenders to review your credit indicates you are on a borrowing binge and a credit default is likely to occur.
Solution: Be sure to minimize the number of loan inquires you do, and Avoid the department store credit cards for 20% off your merchandise. Note that credit scorers ignore auto and mortgage inquiries that occur within 30 days of a score date, since it is normal for people to shop around for these types of loans.
Self inquiries, or pulling your own credit score, will not affect your credit score. Neither do inquiries from your existing creditors, potential employers, or businesses that pre-approved your credit by pulling your report without your consent.
Other Things to Consider:
Types of Credit: There are two types of credit, and lenders want to see how you handle both types. A credit card is considered revolving credit because it doesn’t have a fixed number of payment until the debt is paid off and merchandise is owned entirely by you. Installment loans are those that have an end date, such as your mortgage or auto loans. Once you finish paying the debt, the loan is closed.
Non-Credit Related: Lenders also want to see how stable of an income you have. This is particularly true with mortgage loans. Lenders will often do an employment background check to see how stable your job is and if you hop around a lot. They may also be interested in seeing how long you have lived at your current residence.
What’s the First Step to Improve My Credit Score?
The first step in improving your credit is to know where you stand and to make sure the information used to calculate your FICO score is correct and up-to-date.
Under the FACT Act, you are permitted to receive one credit report a year from each of the credit reporting agencies. You may request all three at one time, or stagger them throughout the year by ordering one at a time.
If you have not reviewed your credit report in few years, it is recommended to request all three at the same time to review them for accuracy. You can request copies from AnnualCreditReport.com, the official site for the federally regulated free credit report.
When you review your credit report you are looking for accounts that you did not know were open. You will want to contact these lenders and close the accounts. You also want to carefully look for errors and inconsistencies. The reporting agencies are not perfect, and it is possible that a lender inadvertently reported a delinquency on your account.
With so much personal information and credit card transactions taking place online now, you also want to look for possible identity theft and fraud activity on your credit report. Equifax offers a daily credit monitoring service, which has a great fraud alert service.
If you discovered errors or fraud activity on your account, you may have some work cut out for you. The Fair Credit Reporting Act gives consumers the right to challenge the accuracy and fairness of information on their credit reports, but it can cause some headaches.
Your credit report will only disclose the activity on your account. In order to see your actual credit score, you will have to pay to get your FICO score. If you apply for a loan, the lender may share your FICO score, but otherwise you will have to order a copy from a service provider, such as MyFico.com, which has a 30-day free trial of Score Watch.
Millionaire Money Habit: Your credit score is your financial report card, and is probably more important than any report card you received in school. This one will follow you for years and determine your ability to qualify for loans at the best possible rates. Lower rates reduce your expenses and may allow you to buy a nicer home or automobile upgrades. Protect your credit score with your life and monitor it regularly to prevent abuse.
