Credit scores are treated as if they are some mysterious beast. We are made to believe that through the worship of debt, we can increase our score. And that score is a badge of honor to be shared among friends at social gatherings.
Having a great credit score is important if you are planning on a large purchase such as a house. Just two percentage points, say from 5% to 7% on a $250,000 mortgage, is the difference of about $320 per month on a 30-year loan. Over the life of the loan, that is an extra $115,000 in payments.
Additionally, you need a score over about 620 before a bank will even consider giving you a VA home loan. So I won’t argue with you that you should move your credit score from the negative to the positive prior to getting your next loan.
Across the internet, you will find articles recommending you open new credit cards and take out loans to improve your score. Sure these might help you increase your score by creating a credit history, but that is only one portion of what the credit score is made of. And besides, do you really want to go into debt to improve your ability to go into further debt?
Instead, credit scores are derived from information found on your credit report. The single best way to increase your credit score is to fix what is wrong with your credit report. Without further adieu, let’s get into how to fix your credit report and your credit score.
Obtain your Credit Report
Years ago, television and internet advertisements were full of services offering you to see your own credit report and credit score for a fee. They often hid the fee by placing the word FREE in their name.
Due to their deception, I will not even mentioning their names. There is only one website directed by Federal Law to provide free credit reports. That site is Annual Credit Report.
As the name suggests, you get one credit report per year from each of the big three credit reporting companies; Experian, TransUnion, and Equifax.
You do not need to review all of the reports at the same time. This allows for you to get one report every three months if you are concerned about identity theft.
Once you are at the site, follow the red buttons which say “Request your credit reports.” The site will have you fill out some information about who you are. Yes, you will need your social here as it is the number used to track your credit history.
You will then be directed to chose which company you would like your credit report from. After making this choice, you may be asked further questions to confirm you are who you claim to be. These questions may be an address you previously resided at, the monthly payment on a loan, or any other personal information which is found in a credit report.
Once you have passed the test, you can review your report. A word of caution here though; these companies are only required to offer you the credit report for free. Once in the site, they may try to offer you services such as credit monitoring or sell you a credit score. It is up to you, but remember, we are only on the site for the free credit report.
Also, prior to leaving the site, ensure you have a copy of the credit report saved to your computer for future reference.
Reviewing your Credit Report
Now that we have a credit report, let’s get down to reviewing the document to find any errors. You will want to review all of the accounts that are present in your credit report. If you are a victim of identity theft, you may discover there are loans and credit cards which are in your report that you do not recognize. Make note of these.
Look for any old accounts, such as credit cards you haven’t used in years. Are they charging you inactivity fees which are compiling? And as a result, the credit card is reporting you as delinquent? If so, it is time to pay off that debt and cancel the cards. Owing money to people is a sure way to not get a bank to give you more.
Review what items you have in collections. Make note of them as you must fix these. There is no way around it.
Take note of your payment history. If you are confident you are paying your bills on time but a company is reporting you are late, then take notes of this.
Something to consider is that not every credit institution reports to all three credit reporting companies. As such, you may find items on one report that is not on another.
Dispute the Inaccuracies
If you have discovered inaccurate information on your credit report, you will want to dispute these items. The Federal Trade Commissions recommends notifying the credit reporting company in writing. They offer a sample dispute letter to the credit reporting companies here. When you send the letter disputing the items, provide copies of any documents you have which may support your case
You will also want to send a letter to the financial institution which is reporting the incorrect information. Your credit report should have the mailing address for the financial institution so you can send the letter to them. Again, send copies of substantiating documents to your claim. A sample dispute letter to financial institutions here.
Time Heals All Wounds
Something you may have noticed is the late payments in your credit report. If you were late on a payment, you were late on a payment. You can’t get that removed from your report by contacting the company.
But there is a shred of light, credit reports are forgiving. In your earlier life, you may not have been as responsible as you are now. Luckily, the credit reporting companies understand this and have a “statute of limitations” on your negative payment history.
Should you turn yourself around and come current on your debts, the old information falls off, one month at a time. For revolving credit, such as credit cards, this could take several years. For mortgages, this could take only two years.
How your Credit Score is Impacted by your Credit Report
There are several factors which taken into considerations when calculating a credit score. These include your credit card use, payment history, derogatory marks, credit age, number of accounts, and inquiries. The following is a break down of their items and their importance.
Credit Card Usage
Credit cards are seen as a higher risk than traditional loans for one reason, the amount of money you owe can go up. As such, your credit card usage has a high impact on your credit score.
The usage is calculated by the total amount of debt you carry on all of your credit cards divided by the total amount of total debt. So if you had a combined credit card debt of $1,500 on a combined credit limit of $10,000, your credit card usage would be 15%.
Having a credit card usage under 10% is considered excellent. But if your credit card usage moves to 30% or higher, then it will have a negative impact on your score.
A word of warning. Many articles you will find online recommend opening new credit cards but not necessarily using them. The idea behind this is to increase your credit limit to make your score appear better.
This might seem like a great idea, but having too much revolving credit is actually negative to your credit score and to your ability to retain your security clearence. Remember, credit cards go up in value and the more cards you have, the higher the potential for you to spend more than you can pay.
Please don’t follow this advice. These articles probably have affiliate links that are making them richer while you are putting yourself in a harder position financially. Let’s avoid doing that and do the one sound thing to increase your credit score; pay down your credit cards.
Remember when I said having under 10% was excellent. Guess what, 0% is under 10%. If someone tells you that you MUST have a balance on your credit card for a good credit score, please consider their financial status. Are they broke? I bet they are. Don’t let all of their lavish or foolish spending trick you, and never take advise from broke people.
Payment history has a huge impact on your credit score. Especially when you realize your credit score is considered an indicator of your ability to pay back debts. Payment history is so important that if you are late on 2% of your payments you could negatively impact your score. If you can’t pay what you have right now, how are you supposed to pay any new debt?
As mentioned previously in the section about reviewing your credit report, look for areas you are reported as delinquent in. If those accounts aren’t yours or you know you were on time, then despite them.
If you were honestly late, well now is the time to turn over a new leaf. There is no magic bullet to fix your bad history other than time. Make it common practice to pay your debts on time. This can be completed with auto bill pay through your creditors.
Again you will get bad advise on not using auto bill pay. The root problem that people have with auto bill pay is they don’t believe they will have the money when the bill comes due. That is an entirely different problem. If you can’t afford your cable bill, get rid of your cable service.
More bad advise you can find is from articles recommending credit cards again. The idea here is that you will have more accounts and more monthly payments. In doing so, it will help improve your percentage of late payments.
Again, let’s not get into more debt for the purpose of improving our score. If you can’t pay your current credit cards on time, why do you think you can pay a new one on time?
Derogatory marks also have a high impact on your credit score. These marks can be debts turned over to collections, foreclosures, repossessions, and tax liens. Having a single derogatory mark will negatively impact your credit score.
If you discovered and derogatory marks which were incorrect, remove them with the disputing methods mentioned above.
Should you have something in collections, work with the collection agency to pay that debt off.
Unfortunately, items such as foreclosures can only come off with time. How much time? It could take up to 10 years for these items to disappear.
Credit age is the average amount of time you have had credit. What the credit reporting companies would like is for you to have years of history on paying your debts back. Your average credit age has a medium impact on your credit score.
As the credit age is the average of how long you have had all of your debt, getting a new credit card will lower your average. Remember all the time’s people mentioned you should get a new credit card to help your score, well this is where their advice is hurting you.
If you already have a credit card you are paying in full every month, why would you need a new one anyway?
This portion of your credit score keeps track of the total number accounts you have currently opened and previously closed. Having more than 10 total accounts will help your score.
But don’t worry if you don’t have that many accounts open. This portion of your credit report only has a LOW impact on your credit score. So please don’t take out more debt for the sole purpose of increasing your credit score.
Remember, the average age of your credit accounts has more impact than the number of credit accounts.
Hard inquiries are the number of times your credit report was pulled. This will occur when you are applying for loans or other lines of credit. With your permission, the creditors will pull your credit report.
The credit reporting companies see this as having some increased risk in the near future as you may be taking out more debt. But have no fear if you are merely getting a quote on a loan as this has a low impact on your credit score.
There is nothing you can do to remove these from your credit report other than waiting two years. Though, it is believed their impact will actually fade prior to that point.
For years I have used Credit Karma to augment the time between pulling my credit reports. Credit Karma keeps track of your credit report and will even email you when a new account is opened. Almost like a free credit monitoring service.
In addition to tracking what is reflected in your TransUnion and Equifax credit reports, Credit Karma will give you an estimate for your credit score from both agencies.
I have people object to using websites that offer this service. The concern is that they will constantly be pulling your credit report and as mentioned above the inquiries will lower your credit report. Have no fear, these pulls of your credit report are considered soft inquiries and as such do not affect your score.
Be warned though, this service is free because of the extensive amount of credit card offers they have. Please look beyond these offers and use the site for the credit reporting service it offers. Don’t worship your credit score as some false idol and make financial mistakes.
The Bottom Line
Having a better credit score will definitely reduce the cost of obtaining financing on a large purchase such as a house. Your individual credit score is determined based on the information found within your credit report.
Unfortunately, credit reports may contain inaccurate information. As such, you should review your report at least annually, and a few months prior to obtaining a loan. Make sure you dispute any inaccurate information with the credit reporting agency and the financial institution who created the error.
After correcting errors, the best way to increase your credit score is to pay the debts you have on time and in full. Time is the second best way to increase your credit score. The mistakes of your past will eventually fall off of your credit report, provided you are making your payments now.
The one thing you should never do to improve your credit score is to obtain more credit cards and taking out more loans. Your goals should be to improve your financial status. Believe it or not, but obtaining debt only puts you further into debt.