"If you don't take good care of your credit, then your credit won't take good care of you." -- Tyler Gregory
Tyler Gregory is right: If you don't use credit responsibly, you will probably pay for it -- in the form of steep interest rates or even rejections from lenders. A healthy credit report, featuring timely payment after timely payment on various accounts, reported to credit bureaus, will result in strong credit scores that can make your financial life easier.
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An intro to credit scores
As you go through your financial life -- paying bills or not paying them, and doing so on time or late -- records are kept and reported to the major credit agencies. Data from your credit records and histories are then used to calculate credit scores -- there are many kinds -- and these scores are used by prospective lenders to help them decide whether they want to lend to you and what kind of interest rate they want to charge you.
Credit scores fall in different ranges according to which score you're looking at. Basic (non-industry-specific) FICO scores, which are used by about 90% of top lenders, range from 300 to 850. Here's how the folks at FICO rate the scores, along with how good or bad they make you look to prospective lenders:
Why your credit score matters so much
If your score is just fair or poor, you should definitely work to improve it. It can be well worth it to boost a good score, too, to very good or excellent. Here's an example of why a good score is very desirable -- reflected in the kinds of interest rates you may be offered if you're borrowing $200,000 with a 30-year fixed-rate mortgage:
The difference between the highest and lowest interest-rate range in the table is $186 per month (which is $2,232 per year) in mortgage payments -- and about $67,000 in total interest paid. Having a high credit score can save you tens of thousands of dollars.
Clearly, fixing a bad credit score can save you a lot of money.
Increasing your credit score
So how do you go about fixing a bad score? Well, a relatively painless way to start is to review your credit reports, to see if any faulty information has been reported about you. If your credit histories contain errors, then your credit score will not be representing you accurately. You can get free copies of your credit reports once a year from each of the main credit reporting agencies at www.annualcreditreport.com -- and it's smart to do so, no matter what your score is. If you spot errors, each agency has ways for you to go about getting them fixed.
Other effective ways to improve your credit score are tied to the components of the score. Improve the components, and you'll improve the score. Here are the components of a typical FICO credit score, and the influence that each has on the score:
Based on those factors, it's clear that having a lot of timely payments is good for your credit history. Aim to make every payment on time, in fact. Just about any creditor can report you to credit agencies -- landlords may report you, as might owners of a storage unit you rented and plenty of others to whom you owe money. Even a late or unpaid library fine can end up dinging your score, as can overdrawing on a line of credit at your bank that's meant to protect you from overdraft fees.
Next, aim to have borrowed only about 10% to 30% of the sum of all your credit limits. That's your credit utilization ratio. Lenders don't want you to have maxed out your credit limits or even come close. (It can help to get your credit limits increased, too.) If you have a lot of debt, it may not be easy to get it all paid off, but it's in your best interest to do so -- at least with high-interest rate debt. Know that many people have paid off tens of thousands of dollars of debt -- some more than $100,000! -- and have gone on to live financially healthier lives. One of the most effective ways to get out of debt is to pay off your high-interest rate debt first. Those credit card rates of 20% or higher are much more costly to you than a 5% mortgage or car loan.
You can't control the overall length of your credit history too much, but you can be sure to not close out old credit card accounts, as older histories are more valuable. Similarly, if you have, say, a three-year car loan and you're thinking of paying it all off at once, know that it can help your credit score to keep that loan on the books for the full three years, with the record showing that all payments were made in a timely fashion. Opening new credit card accounts can hurt your score, as it will lower the average age of your credit accounts.
Finally, if you're shopping for a mortgage or anything that results in your credit score being looked up by a lender, try to do so within two to six weeks. A lot of inquiries can lower your score temporarily, but less so if they're bunched together. It can also be worth delaying getting a mortgage for a year or two, if need be, if you can significantly boost your credit score during that period.
Keep an eye your credit score
Of course, it's hard to evaluate your credit score and know if you're improving it if you don't know what it is. It used to be harder to find out what your score is, but there are ways to access it online now, as well as many credit cards that offer free access to it and some websites that offer free access to it, too. According to the Consumer Financial Protection Bureau, some of the sites will fund the access through advertising sold on their website, while others will want you to sign up for a credit monitoring service. Such services aren't free, though there may be a free initial trial period. You could also find and consult a non-profit credit counselor, who will be able to show you your credit score and discuss what it means -- as well as offer further guidance about how to establish and build a strong credit history.
One way or another, you can fix a poor credit score and get it up into a range that saves you a lot of money. Start taking some actions now. Even if your score is "good," there's room for meaningful improvement.
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