Dear Debt Adviser,My credit situation isn't ideal, and it is greatly affecting other aspects of my life. My credit score is currently 555. I am unable to get my own apartment without a co-signer. For that matter, I need a co-signer for anything that requires credit. I obtained a free credit report and it contains a few accounts that are in negative standing, have gone to collection or have been charged off by the creditor. Some people advised me to contact my creditors to set up payment plans. They said this would help make my credit better. Would creditors be interested in this? And if I set up payment plans to pay my debt, will my credit improve?-- Josh
Dear Josh,Welcome to the world of modern credit. You are finding out the hard way that credit affects more than our ability to borrow money. My expectation is that credit histories will affect more aspects of everyday living in the years to come. That's because credit is frequently viewed as an outward sign of a person's reliability. The thinking is that, if your credit is out of control, chances are the rest of your life is, too. People need to remember that their credit and their personal lives are inextricably intertwined.
As you have learned, potential landlords review credit as part of leasing decisions. Insurance companies use credit reports in developing your risk assessment. And, most damaging in our current job market, employers are increasingly reviewing credit reports before making hiring and promotion decisions.
So I'm glad you have decided to take action to improve your credit and to raise your 555 credit score. Your credit score is based on what's contained in your credit report. So to improve one you have to improve the other.
To help you focus on the most effective ways to reach your goals, let's review the components of your FICO score (the most commonly used credit score). Here are the five major contributors to FICO scores, along with their proportionate importance.
- Paying on time: 35%. It's too late to stop the fallout from any accounts that have gone to collection or been charged off by a creditor. That damage is largely done. So focus on any accounts that are 60 to 120 days late. Try to catch up on the payments. Bring them current as quickly as possible. Also, make on-time payments on all current and new accounts moving forward.
- Debt-to-credit ratio: 30%. You can gain some points by reducing the ratio of your debt to your available credit. Try to keep credit card and home equity debts below 50% of the limit. For example, if you have a $10,000 limit on your credit card, keep the balance under $5,000.
- The length of your credit history: 15%. The longer you've responsibly used credit, the more points you get. Shoot for 10 years of good credit.
- Having various kinds of credit: 10%. Having more than one type of loan shows you can handle different types of credit and payments. There is an exception to this rule, however. Using finance companies reduces your score.
- Accounts opened recently: 10%. The number and types of accounts opened in the last six months can impact your score. Open a new account and points get deducted from your score. Only open new accounts as you need them.
Also remember that there is more to credit than just a score. Paying an unpaid charge off may not do much for your score, for instance. But it will show lenders and employers that, while you may have had a setback, you stuck to your guns and made good on your promise to pay.
Contacting creditors to set up payment plans is smart. If you don't, eventually they'll contact you and it won't be pretty. You don't need a court judgment on your credit report, and that's where you're heading next.
I'll leave you with two last thoughts. One, change won't happen overnight. If you do things right, it will probably take two to three years to rebuild your credit. Two, you really don't have a choice if you want a prosperous future for yourself and your loved ones.