You recently went to buy a car and you were told that you would have to pay 21% interest on the loan because of your credit. But your bank was advertising interest rates as low as 2.99%. You take the loan because you need a new car but you wonder why your interest rate was so high. It’s because of bad credit!
Now you want to know why you have bad credit and how you can improve it. First you need to understand the factors that are considered in the calculation of your credit score. These factors are determined by the credit reporting agencies which are Equifax, Transunion, and Experian. They each keep record of all of your credit history and develop a score as a reflection of your credit standing. This score is known as your FICO score.
Your Fico score can range from 250 to 900 and a higher score demonstrates your credit worthiness to creditors. This score is based on factors such as:
- Open Credit Card Utilization
- Percent of On-Time Payments
- Number of Derogatory Marks
- Average Age of Open Credit Lines
- Total Number of Accounts
- Total Hard Credit Inquiries
Typically, a score above 620 is acceptable. You should have better financing options with a score above this threshold. Ideally, you want to achieve a score above 720. There you will find the most favorable financing options such as lower interest rates for debt financing.
The first step to improving your credit is knowing your score and what your credit history looks like. You can obtain a free annual credit report from each agency free of charge. You should review your report thoroughly to see if there are any items that you disagree with or should no longer be displayed on your report. For example, derogatory marks such as missed or late payments should be removed after 7 years. If you find such items, you can request a dispute. This is a simple way to clean up your report and improve your score.
You can also track your credit score on Credit Karma. It is free to set-up an account and you can view the details of your credit history for two of the three reporting agencies. But FYI, Credit Karma tracks your Vantage score, not your FICO score. So keep in mind when applying for a loan that requires a credit check, your score will depend on which score the lender uses for their loan approval process.
In addition, many financial institutions give you access to your FICO score although they may not show you a full history. Such as the score you see with your credit card company. But also keep in mind, there are 16 distinct versions of the FICO score. So not only depending on the lender, but also the type of loan you are applying for, will dictate which score is pulled. For example, for personal credit lines such as credit cards, lenders typically look at your FICO 8 score. While on the other hand, FICO 5 is commonly used in the mortgage lending industry.
After you ensure the accuracy of the reported information, next you need to implement a strategy to further increase your score. One of the most important things you can do is satisfy delinquent payments. If you find that you have outstanding balances, you can try to negotiate a payoff amount with the creditor. Usually they are willing to accept less than what you owe them if you can pay in full. Keep in mind that the settlement will be reflected on your report and does not look as good as if you had initially satisfied the terms of the loan however, it is much better than having a delinquent payment and it will improve your score.
What else can I do?
One thing you can do to quickly improve your credit score is to pay down your total utilization rate below 30% of your total available credit limit. For example, if you have a total credit line of $1,000, make sure your outstanding balance is below $300. Ideally you should strive to have a total utilization below 10% for the best impact on your credit score.
Another thing you can do is use credit more frequently. This may seem counter intuitive but it helps. You may have heard that no credit is worse than bad credit. This is true because creditors have no way of determining your credit worthiness if you have never used credit. So if you do not have a credit card you need to get one. Even if it has a small credit limit and you may have to get one with an annual fee. The purpose of doing this is to establish your credit. I suggest using the credit card each month to pay a few regular expenses such as groceries and gas. Then you should pay the card off in full each month. For this to work you have to be disciplined. This card is not for purchases that you otherwise could not afford. It is to show that you can be responsible with the use of credit. You will find that once you have proven yourself with the credit card company, you will get better offers to include higher limits, lower interest and no annual fees. You should see your credit improve with this method in as little as a year.
Something else you can do if you are married to someone with good credit is to become an authorized user of one of their credit cards. With this method, you don’t even have to use the card as long as your spouse is using it. The activity of the card will show on your credit report and be reflected as positive history. This will also increase your score overtime and eventually you will be able to get your own credit card for use to improve your credit.
Last but not least…pay all of your bills on time! This is an absolute must to get on track to good credit. Creditors want to see that you will pay on time every time. That lets them know that they can trust that you will pay them back. If you have proven that you can be trusted to satisfy the terms of a loan that increases your chances for more favorable financing options. Derogatory marks because of late payments is a common reason for bad credit. This is something you can correct going forward and as the older marks drop off of your report, your score will improve.
Let’s face it, we need credit. There are just some things we will not purchase with cash such as a home, car or even education. When you go to make these purchases, you want to have the best possible financing options. No one wants to throw money away and that’s exactly what you do when you have bad credit.
Bad credit is usually a result of a certain mindset such as I’ll buy now and worry about how to pay later. Some may even feel it is a representation of character. I know that life happens and some situations are out of our control. Although that is true, we have to take responsibility for our actions that include poor decision making. Credit is a loan, therefore you have to pay it back. If you can’t afford to do so, you should not purchase that item on credit. Learn to use credit, not abuse it! You will be on the road to 0% credit card offers and 2.99% car loans in no time.
