Sometimes people get in over their heads. They rack up so much debt that they're unable to make consistent interest and principal payments. When you're late or unable to make payments, your credit rating suffers. This reduces creditworthiness, and ultimately, it inhibits your ability to access financing.
The good news is that there are things consumers with less than stellar credit can do to improve their standing among lenders and to rebuild their credit score. In this article, we will look at techniques you can use to improve your stats. (For a breakdown of what goes into a credit score and how it's calculated, check out Check Your Credit Report, Consumer Credit Report: What's on It? and The Importance Of Your Credit Rating.)
Credit Score? What's That?
A credit score is the key to understanding how creditworthiness is evaluated by lending institutions, as a good credit score can unlock the vault to help obtain financing.
Your payment history, loans outstanding and a general indebtedness are statistically evaluated by the credit bureaus. The big three of the industry are: Equifax, TransUnion and Experian. Based upon a compilation of that data, your profile is assigned a number between 300 and 850, with 300 being the least credit worthy and 850 being the most credit worthy.
It is this number that lending institutions use as a basis for determining whether you qualify for a mortgage or a quick escort out the lobby doors. So, now that you understand how the score works, let's look at five tips that will help you raise a bad score and win favor with those stern-faced bankers. (For a detailed breakdown of this calculation, see How Is My Credit Score Calculated?)
Tip No.1 - Pay More Than the Minimum
If possible, always make payments over and above the minimum interest payment that is due. Credit bureaus not only look at the amount of debt an individual has outstanding, but also the length of time it takes to pay off the debt.
Unfortunately, there's no calculation that can be used to measure exactly how much this will boost your score. There are a myriad of factors that go into computing a credit score, but accelerating payments and satisfying debts on a timely basis is recommended as a means of repairing credit by lending institutions and well-known credit counseling agencies such Credit Guard of America.
Tip No.2 - Work Out a Plan
Most people don't realize that if they are behind on their debt payments and are going through some trying times, their lenders will often consider negotiating a revised payment plan or possibly forgiving a portion of the debt. For lenders, negotiating is cheaper than either hiring a collection agency or risking that the individual might have their debts cleared in a bankruptcy proceeding.
If you need a reprieve, approach the lender and ask for more time to make payments. You can also present a revised payment structure. If you can develop a plan that works for you and makes sense for the lender, there is a good chance they will accept it. If and when a deal is struck to forgive a portion of your debt, be sure that the major credit bureaus are aware of it and that they make the appropriate notations on your credit report. Less debt and timely payments equal a higher credit score.
You can check to see if the appropriate notations have been made by accessing your credit report, which will document your borrowing and any material changes made to these reports. You are entitled to one free report every 12 months. For more information on getting your free report see the Federal Trade Commission Website.
Tip No.3 - Switch from Credit to Debit Cards
Credit card debt is no friend to your credit score. One of the best ways to avoid credit card debt is to pay the debt right away, through the use of a debit card. (To learn why cards and your credit report have a stormy relationship, see How Credit Cards Affect Your Credit Rating.)
Debit is different from credit. With a debit card, you deposit money into an account and then use the card to charge against the money. There is no credit bill to rack up, and you can only spend what you actually have.
It is important to note that credit reports don't typically factor debit card payments into the credit score equation. But by disciplining yourself and using a debit card to settle debts on the spot, (rather than racking up huge credit card balances) you will, by extension, have a better credit score. (For more on the pros and cons of debit, read Credit, Debit And Charge: Sizing Up The Cards In Your Wallet.)
Tip No.4 - Cut Up Those Store Cards
Many people are just one more card away from witnessing the tragic death of their wallets. The leather strains and stretches to hold in all that easy credit. It's hard not to have an overstuffed wallet when every retailer you visit now has an in-house credit card they'd be ever-so-happy to sign you up for. While these cards often give bonus points, free merchandise or favorable rates, the bad news is that the more open accounts you have, the lower your credit score will be.
From a credit bureau's perspective, the logic behind this is that you could theoretically tap all of these credit sources to the max at one time and rack up a huge amount of debt. In other words, credit agencies and lenders are worried about your potential for taking on high interest debt, as well as the likelihood that you probably maintain small balances on each of those cards. If they don't have an outstanding balance the easiest solution is to simply call and cancel the cards.
If you have balances on numerous cards right now, one excellent solution is consolidating your debt. A personal loan at 12% is still better than the 20%+ rates some cards charge. However, if consolidation doesn't sound attractive, consider paying off the debt that has the highest interest rate first, and close out your accounts one by one as you pay them down. (For advice on debt consolidation, check out Digging Out Of Personal Debt.)
The goal should be to reduce your card count to one or two credit cards. It will make reviewing monthly statements and paying your bills much easier. It will provide discipline as your overall credit limit will be lower, and finally it will keep your wallet from exploding in your pocket, which can be very messy.
Tip No.5 - Add Comments to Your Credit Report
Often when you peruse your credit report you'll find an error. Perhaps you've paid off a particular loan that isn't reflected on the report, or there are legitimate reasons why a particular debt hasn't been satisfied, such as a temporary disability. In these instances your first recourse should be to contact the credit agency and request they make the appropriate changes. Fibbers beware: you will probably have to provide some documentation.
Few people realize this, but credit reports typically have a space for you to provide your comments at the bottom. This section is another area of recourse that can be used. It lets you comment on why a particular debt hasn't been paid or to point out any factual errors. To do this, the individual must contact the credit bureau directly and again may have to provide some documentation to support the claims.
To be clear, adding comments to the credit report won't necessarily boost your credit score. However, some lenders may take your comments into account when deciding whether to grant you a loan. This little-known space can be invaluable if you are fighting an incorrect rating.
A low credit score is not the end of your financial world. Discipline and responsibility can help rebuild even the lowliest of scores. Paying more than the minimum, reducing the number of cards in you wallet, negotiating a payment plan and taking advantage of the comments section on your credit report can all help boost your score and improve your odds of success the next time you need a loan.