First, let’s explain what a credit score is. A credit score is a three-digit number which sums the information up on your credit report, which is how many lenders will determine what the health of your credit looks like.
Scoring agencies use an algorithm that calculates your credit scores, and it includes information such as your credit card balances and the history of your loan payments.
Credit scores were created in order to provide a method for predicting a person’s likelihood of meeting the obligations they have for paying, or the likelihood of a person becoming delinquent on their payments.
There is a common misunderstanding that everyone is only assigned one credit score that is the same for all the lenders and credit bureaus, however, that is not the way it is.
More often than not, most individuals will have several credit scores which are a little different due to the different credit scores using different methods for scoring, and that a person’s credit information is updated often at different times.
You don’t need to try and worry about tracking every single model for your credit score. Instead of worrying about that, focus on keeping track of just the scores from the well-known models that are used by the majority of the lenders in order to qualify you for credit. (Mainly Vantage and FICO)
Despite the difference in scoring models, getting a general understanding of the way that credit score models work will assist you in preparing for understanding your credit score and teach you how to make the necessary changes that will help you in improving your credit score.
How Credit Scores are Calculated
So, to get started, you need to understand that the health of your credit plays a major role for your financial future. Having strong credit health allows for you to be able to qualify for loans while having lower interest rates, which allows for you to be able to save hundreds or potentially thousands of dollars down the road.
Understanding how credit works and what effects it has on you can be difficult and confusing, which can make it hard to know where you should start. If this sounds like how you are feeling about your credit, then no need to worry, you are not alone, and we are here to help!
The first thing you need to do in order to work toward strong credit health is making the investment in learning all the ins and outs of your credit score.
As you can see, The biggest aspect of anyone’s credit score is their payment history. That is why an 18-year-old individual has no credit. They’ve likely never made payments on anything.
Next is the amounts that are owed.
Fun fact: you can have a high credit score but still have no credit to get a loan. Why? Because your “amounts owed’ is simply too high a number. The term “over-extended credit” comes to mind, as that is what that is called.
Then you drive into the length of credit history and new credit. New credit is good because it means that you are using your credit. Length of credit history is just what it sounds like: how long you’ve had accounts open with debts owed.
There are also different types of credit. Your standard credit isn’t actually mixed with your medical credit. Basically, unpaid hospital bills won’t prevent you from buying a house. However, they also don’t impact your credit score quite as much.
Understanding Your Credit Report
There are three categories that information is classified into on your credit report, these are:
Credit Inquiries
This is when you apply for credit and the lender pulls your credit report. This appears on your credit report as either a hard inquiry or a voluntary inquiry. The only inquiries visible to others are hard inquiries, which can impact your credit score for up to a year, but it will show on the credit report for up to 2 years.
Collections and Public Records
This is the information that is overdue debt from the collection agencies and this can include liens, foreclosures, wage garnishments, bankruptcies, and suits.
Credit History
This is the history of your number of closed or active accounts (such as auto loans, mortgages, credit cards, etc.), the credit utilization rate, payment history which includes the severity as well as the number of payments that are late, and the account balances.
General identification is also included in your credit report about yourself, information such as your address, date of birth, name, and Social Security number. Information that is not included is:
Your job information such as occupation, employment history, date employed, and title. Lenders still might consider this information in order to make their overall decisions for approval.
Now it is important to remember that despite lenders using the information that is in the credit report to understand your credit profile, there are still many other things outside of your credit report that are used to make the decision for credit.
Now based on the FCRA, or Fair Credit Reporting Act, everyone is entitled to request a free copy of their credit report once a year from all of the nationwide companies for credit reporting, specifically TranUnion, Equifax, and Experian.
If you are looking to get your free credit report, there are several ways to do this, you can visit their website at AnnualCreditReport.com, call their number at 1-877-322-8228, or you can fill out their request form then mail this to their P.O Box at Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.
You should not contact the nationwide companies for credit reporting individually. There are millions of pieces of data that are collected by credit bureaus which are used by scoring agencies as well as others in order to create your credit scores. The question is, where does all this data come from?
When talking about credit, credit card companies, banks, and other lenders all have a dual role. The first thing they have to worry about is approving individuals for the credit they are looking for. The other role they play a part in is sharing the information they have with credit bureaus involving the credit behavior of consumers, which is then turned into credit reports.
If you have any creditors or lenders that you owe any type of credit account to, these lenders will report your credit activity to the main credit bureaus. This includes any details such as account balances, the amount due, the amount paid, and the status of the account.
Anytime that you apply for any type of credit then a financial institution requests to view your credit report from any credit bureau, this is now included onto your credit report as a hard inquiry.
FICO as well as VantageScore, and any other scoring agencies all use the information available on your credit report in order to calculate the credit score. The range for FICO and VantageScores go from 300 to 850 and they incorporate five different factors into creating your credit score. These factors are the average age of accounts, credit utilization, the types of credit that are in use, new credit, and payment history.
So What Do You Do If You Are Just Starting Out?
If you have just turned 18 and new to having credit, having no credit is similar to having bad credit, so the first step you want to take is to build your credit score. To do this, you will first want to get a credit card in order to start building your credit. Most banks will typically offer around $800 in order to help those with no credit history begin to build their credit.
However, it is important to remember to completely pay off your card every month, making all your payments on time. The reason for this is that it will allow you to be able to extend your credit further and build more credit. When lenders see that you are responsible with your loans, they are often willing to lend more.
It is also important that you do not get ahead of yourself or greedy with the amount you spend. A loan is just that, a loan and it will need to be paid back. You do not want to get to a place where all you can afford is the minimum balance on your loans, this will reflect on your credit score and will hurt your progress when trying to build credit.
Improving Credit
Now that you understand your credit score, it is time to go over improving it. Before you can do this, you first need to know what your credit score is. Not just with one of the bureaus, but with all three of the major credit bureaus. To do this you will need to run a credit check. You can do this in a variety of places, some of which will charge you for the information, but we have the option for you to do so here, at no cost! Simply fill out your information in the form below and we can get your credit report for you.
If you have bad credit currently, now is the perfect time to improve it!
Take a look at your credit report, determine if you can pay off anything that is currently listed on your reports. You do not have to pay off the full amount, you can pay what you can afford to slowly clear out your credit report of any negative items. It can be beneficial to contact the creditors listed and make arrangements for your payments if paying them off in full is not possible. Start with your smaller debts that are manageable and go from there.
With larger amounts it is best to negotiate with the lenders in order to reduce the principal balance for percent on the dollar. Lenders, oftentimes will accept 10-20% on the dollar for second position loans. This will provide you with an opportunity to lower your debt massively, in some cases. Doing so will be a drastic improvement for your credit score.
If you have student loan debt, now is the best time for you to get better interest rates and lower payments for your debt. Right now the CARES Act reduces all student loans to $0 until 1/31/21. The only downside is that alternative repayment plans are only available for certain federal student loans.
There are even repayment plans that can allow no payments for those suffering from hard times that leave the payment at $0 and still show that you are making your payments regularly, which will help to improve your credit score!
Reducing Debt
Now, if you do some research online, you will find a lot of tricks and tips to help you improve your credit score but you need to know one thing. There is no tip or trick you can see, read about, or learn that will impact your credit score more quickly or effectively than being on time with your bills and using any credit cards you have judiciously.
So, reducing your debt is the most important method for improving your credit score. Let’s go over an example to help you better understand how reducing the debt you owe can help you. John has a second mortgage debt of $150,000 and called his lender in order to reduce this debt. He settled with the lender for 10% on the dollar making his new cost $15,000.
This allowed John to lower his debt drastically and improve his credit score as well.
In order to negotiate with a lender you can do one of two things, you can contact the lender directly yourself or you can hire a third party who will work with the lender on your behalf.
The most adverse effect to your credit will come from the large debt amounts on your credit that remain unpaid. Sometimes, despite negotiating with a lender multiple times, a lender may refuse to settle. In this case, you may have to choose a different route in order to get on a payment plan. While a payment plan is great, it can take a long time to pay off your debt, which makes the process of improving your credit both time consuming and painstaking.
Reducing Interest
As your credit improves, it will allow you to have access to better, lower interest rates as well as terms that are more favorable. The best way to obtain the lowest interest rate is through improving your credit score to the best possible credit score.
You need to keep in mind that there is not a quick method to raise your credit score magically overnight. Fixing credit takes time and it is important to ensure you handle your credit well from the start in order to allow yourself to have access to the best interest rates. When your credit score is not where you would like it to be, there are several options you can try in order to raise your score.
The first thing you will want to do is to catch yourself up on any past due payments you currently owe, such as credit cards or utilities. Another option is to lower the amount that you currently owe in credit by paying it off or getting a reduction. If you are using up too much of the available credit you have, this can make your credit score go down.
You should also be cautious about closing the oldest credit card accounts you own as this can create a drop in your score as well. If you plan to apply for something like a mortgage within the next year, it is important to improve your credit score before applying.
Consolidate Any Higher Interest Loans
Consolidating any higher interest loans you may have, such as credit cards, when possible, to personal loans with an interest rate that is lower is always a good option. Since you do not have to pay as much towards interest each month, these loans will allow you to be able to pay off your debt a lot faster. This can be a good option so long as you are able to follow these two basic guidelines.
The first thing you need to do is to stop using any credit cards you have entirely. If you are in a situation where you are continuously going into debt every month, there is no point in your borrowing money.
The second thing you need to do is to avoid attempting a debt consolidation loan on your home by a second mortgage or through a home equity line. This will put your residence at risk if you are ever in a position where you cannot pay back your debts.
Don’t rush your decision when looking for a good consolidation loan, this can be the deciding factor on how much money you save, so take your time. It is also important to stop using your credit cards while you are shopping for your consolidation loan. You can create a goal of not using any credit cards for around 2 months in order to prevent you from being in that habit at the time you take out the consolidation loan.
Open an Account at a New Bank
Having a checking account with a bank can sometimes allow you to obtain lower interest rates on car loans or lower mortgage rates. When you are facing a large loan, such as a mortgage, it can be worth the savings to switch banks. Using a mortgage broker can be beneficial for a mortgage in order to guarantee you find the best terms overall for your mortgage loan.
With the help of a mortgage broker you have the potential to find a mortgage that has the best options for your needs. While it may seem frustrating or difficult to have to switch your bank accounts, it can also be a way to simplify everything for you in order to have all your accounts in one place. There is another option though, you can choose to have an account open that you simply transfer the loan payment you owe into the account every month.
Set Up an Automatic Payment
Interest rates can be lowered most of the time simply by signing up for automatic payments. This can work for mortgages, personal loans, and even car loans. The reason banks like this option is that they are more likely to be paid on time due to the transfer and it will allow you not to have to worry about making your payments every month. You can check your current loans in order to discover if you qualify for this option.
You are able to save on the interest of the loan just by asking a simple question and following up in order to make sure that the lower interest rate will apply to you. Installment loans can be used for this, but typically this will not apply for credit cards. You may even discover that your student loans have this option.
Look at Credit Unions First
Smaller banks as well as credit unions will offer lower interest rates for loans in comparison to a larger bank. While it can take you doing some hunting, you can sometimes find that you are able to lower the interest rate for a loan if you are able to qualify for one through the local credit union in your area.
In order for you to get a loan with a credit union, you first need to be a member of the credit union. This means that there is some specific criteria that you are required to meet in order to become a member, such as living in a certain area or working for a specific company.
Again, it is important to take your time when researching the various rates that are offered from the different banks in your area. This alone can save you a significant amount of money, even more so if you are taking out a larger loan, such as a mortgage. If you are looking to find out what the current interest rates are for a bank, you can usually find this information through the website of each bank.
Creating Equity Using Credit
The way that the banking system and economic system of the United States works is that lenders are able to extend credit for borrowers that have displayed good financial habits. Even small habits like paying the full balance on your credit card every month or paying down a mortgage each month are considered as indicators for the credit worthiness for a borrower.
Once a borrower has obtained a good credit score, they are able to apply for a mortgage, borrow funds, or have the ability to lease or purchase a vehicle all due to the past good faith they have created with their financial debt payments. This is able to work well for the smart consumer that is able to borrow money at the opportune times such as when there is a buyer’s market and the values of property are low. Borrowers are able to create equity through leveraging debt which, in turn, will increase their net worth.
There is a time tested method for greatly increasing a person’s wealth, and that is purchasing property through the usage of leverage. Leverage is using debt or borrowed capital in order to increase an investment’s potential return. The most common method for leveraging an investment in real estate is through using your own funds or obtaining a mortgage. When the values of real estate rise, leverage is working to your advantage, but if the values decline, it can lead to serious losses.
It is important to avoid the risks with leveraging by following these simple steps. Make sound investment decisions and account for the following:
A tough economy
Vacancies
Mortgage payments
Keep in mind that credit can be extended to an individual just for having a social security number by both lenders and banks. So long as you start off paying off that line of credit on time regularly, that line of credit will be increased as you pay off your debt allowing you to borrow more.
