Credit First Aid
Fixing Faulty Credit
Everyone makes credit mistakes at some point in their adult lives. Unfortunately we get very little real world economic training in school. We aren't taught to live within a budget (in fact we are urged daily to buy now, pay later) and all too often our first experience with credit cards leads to a poor credit rating. How many of us got our first credit card in college, or just after high school? How many used it to eat out and go to the movies every night? How many soon wracked up crushing debt loads and soaring minimum payments?
Even if you did alright with your first credit card, an unexpected layoff, extended period of unemployment, business disaster, injury or sickness can cause responsible people to miss payments or even go into collections or bankruptcy. So, if you find yourself with a few dings on your credit report, you're not alone.
The question is: How do you fix your credit now? I'll try to answer that in this article.
Depending on how badly dinged up your credit is, it may take a while to improve your credit and get your FICO scores moving up again. So, here are the steps you need to take.
1. Pull Your Credit Report
The first thing you should do is to pull your own credit report. You may not think your credit is very good, but how do you really know? There are plenty of companies on the internet willing to provide your credit report for a fee. However, the Fair Credit Reporting Act allows you to request one free credit report from each of the three major reporting companies each year. To access this information go to: http://www.annualcreditreport.com. This site is supported by all three credit reporting agencies. They require you to get your report online by starting here. It's easy to use, and in a few minutes you will be looking at your reports from all three. Now, the law says you get the reports for free, but it allows the companies to charge you for your credit score. You don't need to pay for all three scores, but you should get at least get one. At the time of this writing, Equifax charged $6.95 USD, TransUnion $5.95 and Experian charged $5.00. Usually the scores will be within ten to fifteen points of each other, so you don't need to buy all three. There are other services they will sell you too, so be careful, and buy only what you really need.
You are also entitled to a free report anytime you have been turned down for credit. The lender must disclose which reporting agency was used to make their credit determination. You may request a report from the credit reporting agency within 60 days.
2. Examine Each Credit Report For Inaccuracies
Now that you have your credit report, make sure the information is accurate. Check your personal information for inaccuracies. Check each line of credit. You want to make sure the report has accurate information. Now, if you have been late on some payments, been taken to collections, or had a bankruptcy, you can't force a creditor to remove legitimate information from your report. If, however, you find inaccuracies you have the right to have them removed. You will find that each of the reporting agencies have online methods of disputing inaccurate information. When you dispute information the agency must notify the creditor within 30 days. The lender then has 30 days to make an investigation and file an accurate report, so you can see that repairing your credit can take some time. You also have the right to have explanatory comments added to your report. If you were laid off and your payments were late 30 days or more because of that, you have the right to have that noted in your report. You will need to make a written statement to that effect to each reporting agency. Many lenders, especially mortgage lenders, take these comments into account when approving a loan.
3. Understand Your Credit Score
Your credit score is a numerical representation of your credit history. Called a FICO score (named for it's creators Fair Isaac Company), lenders use it as a guide when deciding who to lend money to. A high credit score tells a lender that you will be more likely to pay off your debts than a person with a lower credit score. Most lenders use credit scores in determining whether or not to extend credit. For some lenders there is a hard and fast cutoff point where those above the point get credit, and those below it don't. Most lenders however use the scores to quickly approve high scoring applicants, and weed out very low scoring applicants, leaving the middle group of applicants to be processed by hand. This allows lenders to speed up evaluations for everyone.
The exact make up of each scoring model is secret. The credit reporting companies keep it secret to prevent people from manipulating their scores. While the specific criteria and scoring weights are confidential, we do have general knowledge about what will positively or negatively affect your score. Here are a few things to watch out for.
- Not enough credit lines open. The scoring model needs historical data about your credit to create the score, so you need several good accounts that are current, paid and in good standing.
- Too many credit lines open. If you have too many lines open, you can loose points on the fear that you could suddenly increase your debt to a point beyond your ability to repay.
- The ratio between your credit limit and your credit balance should be about 50%. That means that if you have a credit card with a $10,000 credit limit, you should keep the balance at no more than $5,000.
- Too many accounts with late payments. Keep your payments current. Late payments definitely bring down your score. If you are late, never let your payments get beyond 30 days. Sending in your payments after the due date, but before the next billing cycle will keep you from being reported as late. If you do go beyond 30 days, get a payment in before you go to 60 days. Every time you let another 30 days pass, it gets worse and worse, so get caught up and stay caught up.
- Charged off accounts. If you have a credit account that has been charged off (you didn't pay it, and the lender gave up trying to collect it) this will be a big hit on your credit score. To fix it, contact the original lender and make some arrangement to pay it off. Often times a lender will take a discounted amount to settle the account. Make sure they report the account as paid.
- Collection accounts bring down your score. Get these paid off as soon as possible. Again, make sure they report the account as paid when you pay them. Collection agencies are notorious for promptly reporting bad information, and then not reporting the debt paid. You have a right to have accurate information on your report.
- Judgments against you. If a creditor has taken you to court and received a judgment against you, this will be a big drag on your score. Again, get it paid off and make sure it shows as paid.
- Bankruptcy. This will definitely bring your score down. However, in a perverse way, it may actually help you get credit. Some lenders, especially high interest credit card companies will extend you credit after a bankruptcy knowing that you can't file for bankruptcy again for seven years. Please, if you are in bankruptcy, don't fall into this trap.
4. Make Good Financial Choices
Once your credit reports are reflecting accurate information, the only way to improve your credit rating is to make the right choices for the next two years. Yes, I said two years. Your credit rating is a living entity. It is never static. Choices you make today will affect it for two years or more.
The bad news is that accurate damaging information may be reported for seven years, or in the case of some bankruptcies, ten years. The good news is that your credit score is heavily weighted to the last 24 months. That means that you can improve your score dramatically over the next two years just by being good.
Get on a budget. Ooooh, I just said the "B" word. Tough, get used to it, because a budget is the most important tool you have to regaining good credit. You need to know exactly how much you can afford to spend each month to avoid going into debt. Cut out anything that isn't necessary for life. Get creative with ways to save money. If you need ideas, get a copy of my book, How To Keep More Of What You Make. In it are over 135 specific tips on saving money, and paying of debt. You can order your copy by following this link.
Use the money you save to pay down debt. Always pay more than the minimum payment. Minimum payments are designed to keep you in debt, not to pay it off. In fact, if you make two payments one month, some cards will show a minimum payment of zero the next month. Why? Because they don't want you to pay off the card.
Example:
If you have $10,000 on a card at 8% and your minimum payment is 1% of the balance owing, it will take over 30 years to pay off the debt, and you will pay over $13,000 in interest charges. If you have a high interest card the news is even worse.
If you have credit cards, ask them to increase your credit limit (double it if you can) but don't increase your balances. This will help your credit score to go up because it lowers the ratio between your credit limit and your credit balance. This is critical: DO NOT increase your balance. Keep your balance to limit ratio under 50%.
Be aware of the interest rates you are paying for credit. When you get an offer to move a balance from a higher interest card to a lower interest card, do it! If your credit is still good enough to be getting 0% interest offers, transfer balances to those cards, and make big payments. This will reduce your debt quicker since you won't be paying interest for the introductory period.
Don't close out a lot of accounts at once. Even if your cards are paid off, and you don't use them, don't close them right away, this makes lenders nervous, and can cause your score to go down.
Borrow against your 401k and pay down high interest debt. If you have $5000 on an 18% card, and you can borrow that amount from your 401k account, do it! You'll pay yourself back at a much lower interest rate.
If you need to establish good credit, but no one will lend to you, get a secured credit card. You will have to put $500 into a holding account, and your limit will be just $500, but it will give you the opportunity to establish a new record of on-time payments.
Get caught up with your payments. If you are behind with a creditor, call them and make arrangements to get caught up. Most creditors have programs to help you get current.
Keep the faith. Don't get discouraged. Eventually your bad credit drops off, and in two years you can have better scores, and in seven years, if you make the right choices now, you could have pristine, perfect credit with scores in the 800 range. Then, creditors will jump in front of your car to give you low interest loans.
