The good news is you have credit history. The bad news is that it's time to overhaul your credit reportto get a good credit score.
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It can take years to build excellent credit, but it only takes one mistake to ruin it. The good news is that there are a few tricks you can use to rebuild your credit as fast as possible, some of which will take effect in as little as one month.
Below, we'll explore how credit scores work, and how you can "game" the system to get the best credit score as quickly as possible.
How credit scores work
Credit scores are designed to do one thing: Quantify the risk that you won't be able to make payments on your obligations in the future. For this purpose, credit scores work very well -- on average, people who have higher FICO® Scores are more likely to remain current on their bills than people who have lower scores.
A study by the Federal Reserve suggested that borrowers who have a FICO® Score under 520 had a 41% probability of defaulting on a loan two years after origination. By contrast, those with FICO® Scores above 720 had only a 1% chance of default. With this in mind, it's clear why having a good credit score is so important. A good credit score makes you a lower risk for a lender, helping you get lower interest rates and better terms on virtually any loan or credit card.
FICO® Scores are calculated based on five factors that are derived from your credit report. Some factors, like payment history, are more important than others, like the types of loans you have or have had in the past. When all these factors are plugged into the credit scoring model, the output is a number on which lenders can use to measure how risky it is to lend money to you.
Not every part of the credit score equation can be fixed quickly, but pieces that make up the lion's share of your credit score can be manipulated in your favor.
- Payment history -- For the most part, you can't do anything about the past, but you can make sure you stay current on your payments going forward. Set up reminders or automatic bill payments to make sure that you don't simply forget to make payments. Having many recent on-time payments can help paper over late payments that happened years ago, as it stands as evidence that you're managing your bills better now than in the past. Late payments only hurt your score when you are more than 30 days past due on a bill. That said, it's best to avoid any late payments, since being as little as one hour late can trigger a late payment fee on a bill.
- Credit utilization -- Using too much credit can quickly sink your score. The best way to make the most of this portion of your score is to keep your balances low at all times. Ideally, you'd never have a balance on a credit card greater than 30% of your credit limit. Thus, if you have a card with a $1,000 limit, that means never having more than $300 charged to the card. If you're using a card with a low credit limit, consider making payments more frequently (twice a month, for example) to keep your utilization low at all times, but particularly when you think you'll be applying for more credit.
- New credit -- When you have a low credit score, applying for a bunch of different loans or credit cards will only pile on to your credit woes. Every time a lender looks at your credit report to make a credit decision, it results in a credit inquiry, or a bread crumb that tells other lenders they were looking at your credit report. Too many inquiries can harm your credit score, so it's smart to apply for new credit sparingly when working on rebuilding your credit.
The first step in rebuilding your credit
Your credit report is nothing more than a record of your past and present credit accounts and how you managed them. The fastest way to rebuild your credit score is to establish and keep a "good" account that you maintain in good standing from now until the end of time.
If you have bad credit, having a good account on your credit report is important because it acts as a demarcation line. If all you have on your credit report are bad accounts from three years ago, the credit bureaus will score you based on that information alone -- and the result won't be good.
Think about it this way: If you were a lender, would you rather lend to someone who only has bad marks on their credit report, or someone who has some old bad marks sprinkled in with 100% on-time payments in the more recent past? Of course, you'd choose the person who has been on top of their payments most recently.
There are many ways to rebuild your credit by opening a new credit account, but not all of them are free. Credit unions often offer what's known as a " credit builder loan ," but you could end up paying hundreds of dollars in interest for an account that will eventually fall off your report after it is paid off. Likewise, some stores offer a loan to just about anyone, but paying $300 for a $200 TV, and then paying interest on top, is a costly proposition.
A better solution is to open a credit account that you can keep for life. For this purpose, we think secured credit cards are the best way to go. A secured credit card works in the same way as any other credit card. The only difference is that to open a secured card, you have to make a deposit, which acts as collateral.
Because of the collateral, card issuers will open a secured credit card for just about anyone, regardless of their credit history. Two of our favorite secured credit cards offer $200 credit limits, and require deposits (collateral) in amounts ranging from $49 to $200.
After several months of managing your credit card responsibly, you'll be considered for "graduation," which means your card will turn into an unsecured credit card, and your deposit will be returned to you. Best of all, so long as you swipe your card at least once every six months or so, your card account will remain open indefinitely, helping you build credit that will remain with you for life. My oldest account on my credit report is a credit card I've had for more than a decade -- I use it just enough to keep it open, because having it in good standing does wonders for my credit report.
In contrast to a credit builder loan (which can require a deposit of $1,000 or more), or a store installment plan (which can cost you hundreds of dollars in interest and higher prices), a secured credit card is a no-brainer solution, even if you have bad credit .
Fixing errors on your credit report
It's possible, though improbable, that there may be errors on your credit report that have negatively impacted your credit score. If you learned you have bad credit because you were denied for a loan or credit card, but you're not sure why, you may want to do some digging into your credit records.
Credit bureaus collect billions of pieces of information about hundreds of millions of Americans every year. With information passing between lenders, collection agencies, courtrooms, and credit bureaus, there are bound to be a few mistakes. In a study, the FTC found that about 5% of people have an error that could negatively affect their scores by 25 points. One in 250 people has an error that is negatively affecting his or her score by 100 points or more.
There are many reasons why you might have an error on your credit reports, but some of the most common are listed below:
- You share a name with someone else, and their information was erroneously added to your report. (This happens most frequently when you use different variants of the same name. For example, Robert Smith and Bob Smith.)
- You have an old debt that fell off your credit report, but it resurfaced because the date of the debt was changed to a more recent date. These items can often be removed without much effort.
- You have an account that is reported twice on your credit report. For obvious reasons, if your car loan shows up twice, you'll appear to be a much riskier borrower.
- Your name, address, or birthday was incorrectly entered into the system from a handwritten credit application.
The credit bureaus have a process by which you can dispute information on your credit reports . But first, you'll need to check all three credit reports -- Experian, TransUnion, and Equifax -- to see what's on them. The best way to do that is to go to AnnualCreditReport.com , which remains the only 100% free way to check your credit reports at all of the big three bureaus for free once per year.
On that website, you'll be able to see what's in each report, and file a dispute if you find any inaccurate information. Unless the information you dispute can be proven to be accurate, the record will be simply deleted from your credit report.
Other descriptive information, such as your birthday, name, or address, can be corrected, too, by supplying certain identifying information to the credit bureau. Cleaning up these descriptive errors won't affect your score, but it can eliminate potential hang ups that happen when information you enter on a new credit application doesn't match the information in your credit report. Having an informational error on your report can be the difference between instant approval and getting a notice that the lender will need 7 to 10 days to decide on your credit application.
Rebuilding your credit score isn't an overnight project, but with less than an hour's effort combing through your credit report for errors, making a plan to repay high balances, and applying for a new credit account to put more good marks on your report, you'll be well on your way toward a higher credit score.
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