Cleaning up credit takes time, patience, and behavioral adjustment. It’s also good for your confidence to realize that you’re not alone.
What can you do to take charge? Ask the right questions, and let it lead you to the right behaviors. Let’s begin!
Why Is My Credit Score Low?
Understanding how to improve your credit begins with learning how to build bad credit. That’s right, bad credit.
What are the behaviors, circumstances, and situations that single-handedly (or collectively) created your low rating? Credit agencies use a variety of factors in determining your score, but often one glaring issue can tank the overall by 100 or more points.
Consider a woman we know who recently came to us with a problem. Her credit rating typically stayed a little north of 800. She tried to make all of her payments on time and avoid late fees.
For the most part, she was successful. But then, she received an updated credit score in the low 700s.
For the record, that’s still a pretty great score. But any decline is cause for concern, particularly when you can’t put your finger on the cause of it.
After some back-and-forth, she revealed there were a number of loans and credit card purchases she had made in recent months. Even though she was making all of her payments on time, she was carrying a large balance from month-to-month.
Her credit score suffered because her credit utilization ratio (CUR) was too high.
CUR is the amount of credit used in relation to the amount of credit available. And this is just one of several factors that affect your overall score.
Once you know the determining factors, it becomes easier to monitor your behaviors. If you’re interested in learning how to rebuild credit, here are the actions that’ll get you there.
1. Monitor Your Credit Report for Errors
To develop a quick credit repair plan — or rather a credit repair plan quickly as this journey is one that’s going to take some time — you first need to know the point from which you’re starting.
There are several credit reporting agencies to assist. But the three you need to be familiar with are Experian, Equifax, and TransUnion.
The agencies arrive at their scores using different methods, but they tend to stay within 50 points of one another. As a general rule, you’re not going to have a swell credit rating on one and a horrendous one on another. They’re all good at tracking threat levels.
However, they do make mistakes. Frequently. In fact, over one in five Americans (21 percent) found mistakes on their credit reports.
Think about that for a moment. If you have a total of four friends or acquaintances, then in all likelihood, one of you has a credit report error that’s bringing down your score.
You can see from that why assuming the experts always have it right isn’t a good idea. Still, do your due diligence.
If you’re convinced there is an issue, reach out to the credit reporting agency (or agencies) in writing. Be prepared with any documentation that will effectively argue your point.
2. Stay Away from Credit Limits
Don’t assume your credit score is good if the credit card company raises your limit. They make money from the interest rates they charge. The more you use, the higher interest you pay.
That’s not to say credit cards are predatory. Far from it. In fact, we’ve covered credit cards that are good for people with bad credit in the past.
The bottom line, though, is this: if you charge too much, you fall behind. It goes back to the CUR.
But what’s a good CUR, and how is it configured? Glad you asked!
The credit reporting agencies get antsy if they see anything above 30 percent usage. Let’s say you have a $10,000 limit on a credit card.
You spend $2,800, and you’re probably still okay. However, you’re also drifting close to the limit and not leaving yourself with much wiggle room.
But let’s say that same $10,000 card has a $4,000 balance on it. Well, that’s 40 percent, so at this point, the over-utilization will start to appear on your report (see our example from earlier in the article).
But wait, that’s not all!
A card that has a $10,000 limit and $4,000 in utilization may not be cause for concern if you have other credit that is well-maintained. That’s because CUR is determined by factoring in all of your credit.
So if you have two $10,000-limit cards and the second has a zero balance, then your CUR is only 20 percent ($4,000 utilization divided by $20,000 in limits).
The more credit you have — and the more types of credit you have — the more complicated the math gets. But you get the picture. Using your cards responsibly is ideal.
3. Confront the Past Due
Past due bills, particularly those sent to a collection agency, can do more harm to your credit score than perhaps any other factor. No surprise there. Creditors want to know they can rely on being repaid when they issue credit.
You don’t have to be a professional dot-connector to realize that paying more of these bad debts off will get you out of debt quicker than letting them go untouched. One thing to remember when you do pay off a bad debt, though.
It doesn’t automatically remove the black mark from your credit report. That stays put for about seven years. But taking steps to address it will instill more confidence to lenders, and it can be a powerful determinant if a loan application has you on the good credit-bad credit fence.
Of course, there’s always the fear that if you go crazy paying off as much as possible, you’ll leave too little to live on. From there, you acquire new debt and new collections, putting you into a situation that’s essentially the same (or worse) than it was before.
You do need to manage cash flow. So when you come into money, be responsible with how you pay it back.
Consider paying off one smaller debt as you keep the rest of your daily obligations in check. Then address another the next time you have the financial breathing room. If it’s one giant debt, set aside the money until you can afford to take it out, or make payments toward it.
4. Pay Current Bills on Time
Fair, Isaac and Company (FICO, or the team behind your FICO/credit score) note that missing one payment by more than 30 days can lower your score by as much as 110 points.
Credit scores are measured on a scale from 330 to 830. Considering hat interest rates start to decline below 700, you don’t have a lot of leeway when it comes to making timely payments.
While pretty much no one pays off debt on minimum payments alone — in fact, as we’ve covered before, they’re horrible ideas — these payments can be useful for avoiding delinquency penalties. If you find yourself in a tight spot, remember these two rules:
- Stop using credit cards immediately
- Make the minimum payment on the due date
You can always resume a more aggressive repayment schedule later when money is less tight.
5. Eliminate Debt
Let’s carry over the “stop using your credit card” advice here. It’s difficult to pay off your credit cards when you’re constantly having to reuse them to live.
Say you have a card with a 15 percent annual percentage rate (APR). You owe $5,000, and you think paying $500 per month on it will get the entire debt knocked out in 10 months.
The only problem in this scenario is that you’re also putting $400 per month in living expenses on it. Your payment is enough to cover the new purchases, but the $5,000 balance is still there.
At 15 percent, you’re accruing another $750 in interest for the year. From the $100 remaining of your $500 monthly payment, only about $450 is going toward principal. At this rate, it will be years and not months before you see the end of your credit card debt.
So what’s the answer?
Again, stop using your credit cards. Pay more than the minimum payment, but make sure it’s not so large that it forces you to return to charging.
You might even want to invest in overdraft protection if your bank offers it (most do).
This option results in a charge every time you exceed your available balance. It also breaks the cycle of credit card use that keeps you enslaved to debt.
At the same time, you’ll think a little harder about that Starbucks purchase if you realize it’s going to cost an extra $25 in overdraft fees!
In other words, it teaches you to spend money more responsibly while taking care of your needs and avoiding plastic.
A Word on Using Cash Reserves
Some will advise you to tap into any cash reserves for eliminating the debt in one fell swoop. This can be good advice, especially as a psychological boost, if the cash reserve removes the debt without overextending your budget and creating future problems.
But let’s say your only reserve is a $2,000 cushion, your budget is already tight, and you owe $5,000. That could make the problem worse.
Why? Doesn’t it feel good to say you only owe $3,000 instead of $5,000? Well, not if you’ve depleted your resources and have to resort to using the cards again.
Before long, the debt could go back to $5,000 on interest charges alone; you’ll still be living paycheck-to-paycheck, and you’ll have nothing for a rainy day. One thing goes wrong, and you’re back on the cards.
If you can, consider a debt consolidation loan that pays everything off at once for a better interest rate over a set period of time.
6. Avoid Balance Transfers and Shifting Debt Around
Balance transfers and moving debt around can seem like a good idea, but you’ll want to avoid this for a few reasons.
Firstly, it does nothing to improve your CUR. In fact, you may get a false sense of security from “zeroing out” a card and start using it again!
Furthermore, if your card is at the tipping point, it’s unlikely you have a second card that can handle the balance plus any further use. Maxing out a credit card creates CUR problems.
To deal with the last problem, you’ll probably end up applying for additional cards to get in on the low introductory interest rate. More applications mean more credit checks, which can negatively impact your score.
With each balance transfer, there’s typically a processing fee on the front end. That means you immediately add to your debt.
With that said, there is a scenario where a balance transfer can be a good idea, but it takes discipline. What you’ll want to do: transfer the balance to an “empty” card you already possess (i.e., one that doesn’t require a new application).
If the balance transfer period is 12 months/no interest, divide the total balance after processing fee by 12. Next, make that payment on time, every month.
If you’re late, the terms of the transfer typically state there will be interest incurred. It could even nullify the overall terms of the deal.
7. Train for a Marathon
We’re not saying to do this literally (though it’s not a bad idea for the mental and physical fitness needed to deal with debt). We’re just saying that clawing your way back from bad credit isn’t something that happens overnight.
You have to start somewhere. You have to make better decisions each day. You have to be prepared for setbacks without losing sight of the goal.
This cannot be under-emphasized. Too often, credit solutions are sold as an “easy fix.” But to be effective at this, you have to get your mind and budget in shape.
Unfortunately, you can’t make the exact amount of money you need to deal with everything overnight. It takes time and patience.
Cleaning up Credit Can Be Messy
Repairing bad credit starts with noticing the bad behaviors and situations that created the problem in the first place. Cleaning up credit is about unlearning those behaviors and letting go of a past you can no longer control (if you ever could).
For more tips and advice on how to deal with your credit problems, make sure you stop by our learning center.