If the extension of credit increases spending in the economy, and these components are key in the financial woes of the typical consumer, is it essential to improve my credit?
We as a society are constantly looking at how we can improve our credit.
People try all kinds of methods to accomplish this, but it is actually quite simple. Depending on your situation, you may have established credit earlier on in life but not maintained it. Or, maybe you have never built your credit score. Perhaps you have a good score, but you’re unsure how to improve that score. Whatever your situation, knowing how to manage your credit daily is a good defense tactic.
As you read in the last blog, the FICO score ranges from a low of 300 to a high of 850. The higher the score, the better—within reason. People can be obsessive about their credit score and carry unnecessary credit lines just to ensure that their credit score is ideal. This score is tricky, though, because you can focus so much on building it that it negatively affects your money management. Let me explain.
Your credit score is comprised of payment history on debt, amount of debt utilized, how long you’ve had the debt, new credit lines established, etc. All of this is focused on your responsibility of managing your debt well, which is a poor indicator, at best, of how you are actually doing financially. In building [Margin], knowing where you are and what needs to happen to ensure you are on a solid financial footing includes understanding credit.
So, let’s begin with the following:
1. Where is your credit?
In the last episode, my call to action was for you to pull your new year credit score. Now that you have this information, you have a three-digit number that tells financial institutions how credit-worthy you are. Based on the Experian resource referred to in the last blog, there are five categories:
- Exceptional (800-850)
- Very Good (740-799)
- Good (670-739)
- Fair (580-669)
- Very Poor (300-579)
(I might add that I’m not sure why the scale goes from fair to very poor—but I digress.)
2. Make appropriate corrections.
Based on the information provided by your credit report, be sure that the data is correct and, if it is not, work to have it resolved so that it does not negatively affect you. According to the Federal Trade Commission, 1 in 5 consumers have errors in their credit report.
The Consumer Financial Protection Bureau approached this by looking at four key areas of your credit report:
- Personal information: review your personal information to ensure that what is being reported is actually you.
- Reporting of account status: ensure that accounts that were previously closed still reflect as closed. Check that you are the reported owner instead of an authorized user, as well as if the information shows late or delinquent when you’re not. Look for incorrect dates or even duplicates.
- Balance errors: false balance or credit limit.
- Data management errors: data that was previously corrected being reversed, accounts being listed multiple times with different creditors.
3. No credit score or need to build credit.
If you have no credit, you’re not alone. According to the Consumer Finance Credit Bureau, over 45 million American adults have no credit score. No credit score doesn’t mean your credit is “zero.” It just means that you may not have any institutions or payments being reported. To establish credit, you may consider having someone close to you co-sign, utilize secured credit cards, a credit-builder loan, store cards, or self-reported sources for rent. The latter is widely unknown.
Bankrate.com reported, “The good news is that there are still plenty of ways to share your positive financial habits with credit bureaus. Third-party services like PayYourRent and RentTrack, for example, will report your rental payments to all three of the major credit bureaus.” You may also consider signing up for a service that helps you improve your credit score. Bankrate goes on to say that, “Experian Boost lets you add phone and utility bills to your Experian report, and a history of on-time payments can boost your credit score.” This product helps you to take advantage of getting credit for payments that are not typically reported.
If you need to build credit, continue to the next step:
4. Paying on time.
This is the area with the highest weighted value by FICO (35%); it’s also the area to ensure that you are most diligent in when building your credit. If this is an area that is difficult to remember, set up auto-pay for at least the minimum balance. This action will ensure that you don’t unknowingly get behind on payments. Once you get behind, it is much more challenging to get caught up and stay current.
If you are trying to rebuild your credit, it could be due to any of the above items. It could be due to delinquencies that stay on your credit report for seven years, a bankruptcy that stays on your credit for 7-10 years, or even inquiries that remain on your credit for two years.
5. Amounts owed.
This is what I call “utilization of debt”, and it’s weighted at 30% of your credit score. It is recommended that any revolving debt remains at or below 30% on any type of revolving debt when it comes to balance-to-limit. You calculate this by taking your total utilization on a credit card of $3.8k and dividing that into the available credit, say $12k. This calculation should give you a balance-to-limit of 31.7%. Then, you work to reduce that balance to stay, at a minimum, below that 30% figure. This is typically something in the form of a credit card or line-of-credit. It can also be applied to anything with a credit limit to which you pay based on your utilization through monthly minimums or auto-pay.
6. Length of credit history.
The length of your credit history comes with time (surprise, surprise!). This is weighted at 15% of your credit score. When trying to build your credit, try to hold off on closing credit lines that are not required to be closed. Often, you can pay off a credit card or a line-of-credit that has a revolving balance and still keep the account open. However, auto loans, mortgages, home equity line of credits and the like are closed when they are no longer tied to that underlying asset.
7. New credit.
New credit lines and the use thereof also impact your creditworthiness and are weighted at 10% of your credit score. Institutions see higher risk in people who are applying for multiple means of debt in short periods of time.
8. Credit mix.
If you are trying to build your credit, you have to strike a balance with your credit mix, as this is weighted at 10% of your credit score. You don’t want to have all of one type of loan while balancing the maintenance of your credit score. I believe this is the area that negatively impacts my credit score the most, having just the two credit cards.
9. Maintain.
Your credit report will be your go-to regarding regularly evaluating your creditworthiness as you get into the rhythm of maintaining these aspects. Review your credit report a minimum of once per year.
10. Coupled.
Couple this process with ensuring you have a Plan to Spend. Automate payments toward paying down and off debt, and make sure that you are not adding risk to your life by maxing out or even over-utilizing available credit. Only add credit lines that are low-interest and ideally on items that are going up in value rather than consumables.
Ghost creditors: https://www.consumerfinance.gov/about-us/blog/who-are-credit-invisible/
Self Reporting: https://www.bankrate.com/finance/credit-cards/boost-credit-score-by-self-reporting/
