You just took the big step and got your credit score. Ouch! You’ve discovered it’s in the high 500s. This means you’ll have a hard time getting new credit and may not be able to buy that house you’ve been dreaming about. But don’t panic. There are literally millions of Americans in the same fix – or even worse. Plus, you can repair your credit though it will take time and a fair amount of effort.
Understanding your credit score
Here’s the simple explanation of your credit score – it’s a mathematical representation of your credit reports. Credit scoring was invented back in the 1950s as a way to standardize how people were granted or not granted credit and at what cost. Before credit scoring, lenders were forced to read every line of a credit report and then make a subjective judgment as to a person’s creditworthiness. One lender could review a report and decide the person was a bad risk while another might read the same report and decide the person was a good risk. Credit scoring has eliminated this and made things more objective as different lenders were then able to see the same score and have the same option about the person’s creditworthiness – for good or for bad.
Credit score ranges
Someone then came along and created the idea of credit score ranges, which make it even simpler for lenders. These ranges, which are based on the FICO scoring model, are as follows.
- Between 700 and 850 – Very good or excellent credit score. one
- Between 680 and 699 – Good credit score.
- Between 620 and 679 – Average or OK score.
- Between 580 and 619 – Low credit score.
- Between 500 and 579 – Poor credit score.
- Between 300 and 499 – Bad credit score.
How this affects borrowers
Credit scoring and credit ranges have made it very easy for lenders to determine a person’s creditworthiness. Lenders typically base your interest rate on your credit score. People with “good” or “very good” scores get the best interest rates. Conversely, people with “low” or “poor” credit scores will be charged higher interest rates because the lender believes it’s taking more of a risk. In fact, if you have a “low” credit score your mortgage could have an interest rate two points or more higher than if you had a “very good” credit score. This means that a bad credit score could cost your literally thousands of dollars more over the life of a 30-year mortgage.
Get your credit reports
If you learn you have a low credit score, the first thing you need to do is get copies of your credit reports. You have three of them as there is three credit reporting agencies, each of which keeps a credit file on you. You can get all three free at www.annualcreditreport.com.
Once you have your reports, you need to go over them carefully, looking for those negative items that are dragging down your score. This could be a lien, a judgment, a debt sent to collection, a charge off, a default, maxed out credit cards or late payments.
Step #1 in repairing your credit
Once you find the negative items in your reports that may be damaging your credit score, you need to double check to make sure they are really yours. The three credit bureaus process thousands of items a day and they can make mistakes. You might find a judgment or a charge off that was there due to an error. In this case, you will need to go to the appropriate credit bureau’s website and file a dispute. This is fairly simple as they all have online forms for this purpose. You will need to have documentation supporting your claim. If you do so, the credit bureau must contact the company that provided the information and request verification. If the company is unable to verify the negative item or if it doesn’t respond to the credit bureau within 30 days, the bureau must delete the item from your report – which could mean a nice increase in your credit score.
Pay down your balances
Your credit score is based on five components. They are.
• Payment history – 35%
• Credit utilization – 30%
• Length of credit history – 15%
• Types of credit used – 10%
• Recent searches for credit – 10%
There’s nothing you can do about your credit history as, well, it’s history. But you can do something about your credit utilization and types of credit used – that could help your credit score.
Credit utilization is the total amount of credit you have available vs. the amount you’ve utilized. For example, if you have credit cards with a total balance of $10,000 and have charged $6000 on them, you would have credit utilization or a debt-to-credit ratio of 60%. This is much too high and could be hurting your credit score. Most experts feel your debt-to-credit ratio should be 20% or less. So, if you were able to pay down your debt until you reached that 20%, your credit score should improve considerably. You might also be able to improve your types of credit used by applying for a personal loan, a personal line of credit, a homeowner’s equity line of credit or an auto loan.
The other way to improve your debt-to-credit ratio is to increase the amount of credit you have available. To do this, you would need to contact your lenders and ask them to raise your limits. This can work if you have a great history of making your payments on time and never exceeding your limits. If not, you’ll be out of luck.
Get a secured card
Another way to improve your credit is to get what’s called a secured card. This is one where you deposit money into a savings account. The more money you deposit, the higher will be your credit limit. You can keep using the card so long as you continue depositing money. If you use it sensibly this will be reported to the credit bureaus and will eventually have a positive effect on your score. If you use the card judiciously for a year, the bank may offer you an unsecured card, which would definitely have a positive effect on your score – so long as you use it wisely.
Some other tips for improving your credit score
• Pay all your bills on time all the time
• Keep the balances low on your credit cards and other revolving types of credit
• Understand that if you close an account this doesn’t make it go away.
• Don’t close credit cards you are not using as a short-term way to raise your score.
• If you have been using credit for a only a short time, don’t open a lot of new accounts too quickly
• Have you missed payments? Then get current and stay current.
• Don’t apply for new credit accounts unless you absolutely need them.
• Be aware that if you pay off a collection account this does not remove it from your credit report.
• Pay off debt instead of just moving it around
Here’s a video with 5 more tips for raising your credit score.