Bad Credit: 10 Things I Wish I'd Known Earlier
Learn the simple mistakes that can negatively affect your credit before it's too late. You'll thank yourself for knowing how to keep your credit score from slipping.
About twenty-five years ago, I tried to buy a used Honda Civic.
The only loans available to me had astronomical interest rates, so I was stuck without a reliable car and had to buy something with cash.
Then, when I tried to buy my first home, I had a hard time getting a mortgage with a reasonable interest rate.
Because I was oblivious to the fact that I had bad credit.
Later, I checked my credit report and found an unpaid medical bill that I didn't even know about. That alone tanked my score by 200 points.
In my 20s, I was cavalier about paying back my student loans. That is, I avoided the bills. Another knock on my score.
Since then, I've gotten wise to the system. I was eventually able to get the money to start this website.
Had I understood how credit scores work in the first place, it would have made life a lot easier—and less expensive.
Here's the rundown on how to fix your credit score
Your credit score is the number that helps lenders decide whether to give you a loan and the interest rate you will be charged on it.
Scores range from about 300 to 850. Over 750 is considered excellent. Below 600 is considered poor.
The higher your number, the lower your interest rate. With a poor credit score, you are likely to be denied a loan or charged exorbitant rates.
Wallowing at the lower end, I wasn't alone. According to credit rating agency FICO, 20% of Americans have credit scores below 600.
Credit scores affect everything from car insurance to rental leases to job applications.
Yet many people don't learn about this until they need to get a mortgage or a business loan.
By then, they may be in their 30s or 40s and burdened with a poor score.
Americans are shockingly uninformed about personal finance and credit — most receive no formal financial education, which negatively affects their credit score.
Only 17 states require high school students to take a course on personal finance. Just 20 mandate basic economics.
The National Endowment for Financial Education has found that students from states that teach personal finance are less likely to max out credit cards or make late payments. They also have better credit scores.
This lack of education in school hurts consumers when they reach adulthood.
A 2016 survey by the Financial Industry Regulatory Authority found that only 37% of Americans are financially literate, based on responses to five basic questions.
Many people don't know the terms of their mortgage or the interest rates on their loans.
Bad credit will hit your wallet in a number of areas of your life:
- You pay more every time you need a loan or take out auto or life insurance.
- You pay higher interest rates on credit cards.
- Utility companies and landlords check credit history too and might deny or raise the cost of their service.
- Some companies check credit ratings when making hiring decisions.
- In the case of an emergency, a poor credit rating might impede your ability to get necessary funds.
According to a 2015 report by Pew Charitable Trusts, 60% of American households experienced a financial shock in the past 12 months.
If you need to access to quick funds—at reasonable interest rates—you want to have a good credit score.
A good credit score puts money in your pocket; the variation in interest rates can make a big difference as to how much cash goes out each month.
Scenario: Say you have a $200,000, 30-year mortgage.
If you have a high credit rating, from 760 to 850, you'll pay around 3.725% interest, or $923 per month.
On the low end, 620 to 639, interest is around 5.33%, or $1,114 per month. (Rates based on FICO loan calculator.)
$191 a month and $2,292 per year.
Think about what you could do with that extra two grand a year, like buy a computer or fly to Europe!
Over 30 years, that's $68,760 — enough to help a kid through college.
If it were invested in the stock market, the money could more than double:
A $191 monthly investment could become $182,298 after 30 years, assuming a 6% return.
You can check your own potential return on the Security and Exchange Commission's compound interest calculator.
Although overall scores have improved since the 2008 recession, 20% of Americans still have scores below 600, according to FICO.
You control your credit score
Your credit score is within your control. So the sooner you start paying attention to it, the easier life will be.
Trust me, you don't want to be where I was 20 years ago, stuck in Florida without a car.
When I learned these 10 things, I was able to improve my credit score surprisingly quickly.
Even if you're overwhelmed by debt or have had credit requests denied, if you follow these tips, you can take charge of your credit score—and your financial life.
Still not convinced? What if I told you a high credit score could even improve your love life?
A 2015 study from the Federal Reserve Board found that couples with high credit scores were more likely to stay together than those with lower scores. There's even a dating website that matches users based on their credit rating.
1. You can check your credit report for free
Your credit score boils down the information on your credit report — if you care about having a good score, that's where you start.
A credit report is your personal financial report card.
Based on your social security number, date of birth, and address, it rounds up your payment history, which informs your score.
Check your credit report for free once a year on Annualcreditreport.com — and be wary of other sites — this is the ONLY official site for free credit reports.
You're allowed to see a report from the three major credit bureaus, TransUnion, Equifax, and Experian.
Each report will be slightly different. You can check all three at once or stagger them.
Keeping tabs on your report is common sense, writes Tushar Mathur, blogger at Everything Finance. It will help you plan for the future and get yourself on track for future loan approvals.
"Your finances are your responsibility, and just as you get oil changes regularly to preserve your engine, you should be checking your credit rating to ensure that when you need it, it will be there for you," Mathur writes.
"Even if you have a great credit score and seem to be managing your finances well, you never know when a wrench could find its way into the works. So play it safe and request a free credit report annually. You'll probably find that it's well worth the effort."
After you get your report, Annual Credit Report will direct you to Credit Karma, where you can see your credit score for free.
2. Your credit report might have mistakes—and you can fix them
There's a good chance your credit report has mistakes that hurt your score.
A 2012 study by the Federal Trade Commission found that a quarter of American consumers identified an error in their report.
One in five consumers disputed an error in their report and had it corrected. 20% of people who did so saw their credit score improve.
When finance blogger Scott Alan Turner first checked his credit report, it showed him living at an address connected to a credit card account opened under the name Scott Alan Turner Jr.—all of which were unfamiliar to him:
"Interesting, because there is no Scott Alan Turner Sr,... As you go through your credit report, you might find errors in your personal information, incorrect accounts, or account details."
Errors will almost certainly appear if your identity has been stolen since thieves could open up fraudulent accounts in your name.
The 2017 Identity Fraud Study found that a record 15.4 million Americans had their identity stolen last year.
It's scary to think that your credit score could be dinged for something you didn't even do. The good news is that you can fix it.
If you identify an error, the first step is to alert the credit reporting company in writing. The FTC has a sample dispute letter on its website.
Under federal law, credit reporting agencies must investigate the items you flag, usually within 30 days.
The next step is to alert the information provider, like the bank that provided the erroneous detail to the credit reporting company. You'll have to send another dispute letter, by mail, with copies of documents that support your claim.
If the credit reporting company makes a correction, you can ask them to send a notice of the change to anyone who's requested your credit report in the last six months.
They can also send a corrected report to those who have checked it for employment purposes in the last two years.
3. Legitimate credit repair services can help improve your credit score
You don't have to fix your credit report on your own. If it feels overwhelming, consider turning to the pros.
Credit repair services can help you identify and correct mistakes, or negotiate with lenders on your behalf.
Before you sign up a service to help improve your credit score, make sure it's legitimate. Ignore ads that promise to "Legally Erase Your Credit History!"—they're likely signs of a scam.
Writing on Planting Money Seeds, Miranda Marquit lists some red flags that indicate a shady credit repair company:
- Charging a fee in advance. This is a big no, no. By law, a company is not supposed to collect their fee until they have provided the services promised.
- Withholding your rights. Credit repair companies are required to disclose your rights to you and let you know the ways in which you can fix your credit on your own for free. Any company that does not do this is breaking the law.
- Recommended by the FTC. Beware any company that claims they are endorsed by the Federal Trade Commission (FTC); this is a straight up lie as this organization does not endorse any business.
- Make a new identity. Under any circumstances, do not work with companies that suggest you try and create a 'new' identity.
4. You should pay off your credit card debt as soon as possible
According to FICO, paying off your credit card debt is one of the most effective ways to improve your credit score. The amount you owe affects 30% of a FICO Score's calculation.
It's challenging and requires discipline, but the sooner you pay down debt, the less you will owe in the long run.
After years of only paying the minimum monthly amount due, Grayson Bell of Debt Roundup wracked up $50,000 in credit card debt.
He and his wife spent four austere years paying it off.
Bell had to think about which credit card debt to tackle first. The two options typically recommended are to:
- Pay off the card with the lowest balance (fastest gratification).
- Pay off the card with the highest interest rate (biggest return).
Bell chose the latter, nicknamed the avalanche method. He listed his debts by interest rate and tackled the one at the top first.
"In my case, my higher interest rate debts were also some of my higher balances. This caused me to work harder and longer to pay them off, but it also saved me the most money via interest payments," Bell writes.
"When you take out the highest interest rate first, you are saving the difference in percentage rate from one debt to the next…This method makes the most sense financially and mathematically, but it will not work if you don't have the will power to continue the debt reduction plan."
When I was building my credit back up post graduation, a little technique that helped me stay persistent was setting milestones.
In a little journal, I kept a timeline of my credit score as it rose, with a future score that if, or rather when I hit, "unlocked" a personal reward—highlight reels of the Florida Gators on YouTube, or tickets to the next Tampa Bay Buccaneers home game.
5. It's really important to pay your bills on time, or at least within 30 days
Your payment history contributes to 35% of your credit score. FICO says that even sending in a check a few days late can hurt you.
Paying bills on time—for utilities, doctors, or credit cards—is vital. With so many to remember, it's wise to come up with a system to be sure you're covered.
The easiest method is to set up automatic payments on recurring bills so you never miss a payment. Or if you're more of an analog person, write due dates on your calendar.
But there may be a little wiggle room with credit cards, says Sam Dogen, aka the Financial Samurai. So don't panic if you're a few days late.
Rushed to pack for a trip, Dogen once forgot to schedule his normal credit card payment and missed the due date.
"The first thing to realize is it's not the end of the world if you accidentally miss a credit card payment. Things like this happen all the time, and the hammer does not fall on your credit score so quickly.
"The second thing is there's a grace period to how late you can be before getting hurt. Being three days late is much different from being 30 days late. But being 90+ days late is a disaster!"
Dogen has missed due dates four times. On each occasion, he called the card company within a week to explain himself and ask if they'd waive the missed payment fee.
"Each time they said yes, partly because I have demonstrated years of regular payments, and partly because I always called shortly after realizing I was late. As a result, my credit score was not hurt, and if it was hurt, it still stayed above 780, so who cares. Just make sure to ask whether they've reported you to the credit bureaus."
6. Never take out sketchy cash advances like payday loans
You've probably seen the upbeat ads: "Bad Credit? No Problem!"
People with low credit scores sometimes turn to payday loans to get a quick influx of cash. Like most bad credit loans, however, interest rates are staggeringly high.
Though payday loans are generally not reported to the major credit bureaus, they can lock you into a cycle of debt.
As you pay exorbitant interest rates on your payday loans, you may struggle to cover other expenses, further damaging your credit score.
Payday loans are made in anticipation of future paychecks, insurance awards, pensions, or tax refunds.
They are typically due in two weeks, but 80% of borrowers don't pay them back within that time, according to the Consumer Financial Protection Bureau.
The typical cost is $10-30 per $100. An average $15 interest fee amounts to 400% interest over the year. (For credit cards, it's 12 to 30%.)
So for example, if you borrow $200 in January, you would owe $1,000 in December.
According to the Department of Financial Services in New York State, one of many states to outlaw the practice, "Payday loans are designed to trap borrowers in debt. Due to the short term, most borrowers cannot afford to both repay the loan and pay their other important expenses."
If you need a cash advance to cover expenses, don't take out a quick personal loan for bad credit.
New York State recommends working with a Community Development Credit Union, a non-profit organization that provides fairly priced loans to people with an imperfect credit history.
7. Think twice before closing old credit card accounts or opening new ones
If you're fed up with having so many credit cards and bills to pay each month, it's tempting to cancel some. Don't be rash.
Remember that credit agencies consider the length of your credit history when determining your score. You want your credit report to show that you've been paying credit card bills for years.
Philip Taylor, a CPA who blogs at PT Money, writes that when he was trying to bring down his debt, he foolishly closed his oldest credit card. He didn't know that this would hurt his ability to improve his credit score.
When you close a card, you lose its available credit.
"To the credit agencies, you appear to have less available credit at your disposal. They translate this into: not as many people are lending to this person, so they must be a higher risk."
Closing an account will also "make you look younger in terms of credit history," he says. "One of the keys to a good credit score is a long track record of responsible borrowing. So it's important to leave those old accounts intact, even if you're not using it."
That same principle applies to new accounts. If you are a new credit user, FICO advises not to open several accounts quickly. New accounts lower your average account age and make you look risky.
8. Keep balances low on credit cards, even if you pay bills on time
To calculate your credit score, credit bureaus factor in your credit utilization ratio. This is the amount of your available credit that you use each month.
The less available credit you use, the better your score.
You can lower your score if your spending approaches your credit limit, even if you pay it off at the end of the month.
Say you have $4,000 in available credit. If you spend $2,000 a month, you're using 50%.
Credit bureau Experian says to keep that ratio below 30%. Any higher and it indicates that you struggle to manage your finances.
Ryan Greeley of Better Credit Blog explains that your credit score takes into account two aspects of utilization:
Overall utilization. This is calculated by adding together the balances of all of your revolving accounts and then adding together all of the credit limits. After that, divide the balance by the limit.
Individual credit account utilization. This basically means that if you have ANY individual account where the balance is over 25% of the credit limit, it is likely hurting your credit.
"Therefore, even if your overall credit utilization is under 25%, if any one of those accounts have [sic] a balance over 25%, your credit score is affected."
Greeley points out that since the calculation is based on a ratio, not the dollar amount, you should consider asking for a credit line increase.
FICO says that if you've had a credit card for six months, and paid bills on time, you might be eligible for a credit limit increase. You can request this online or over the phone.
A high credit limit and responsible spending will give you a low credit ratio and help your score.
9. Becoming an authorized user can boost your credit score
One way to increase your credit rating is to become an authorized user on someone else's account, like a parent or spouse.
Only ask someone who has good credit and always pays their bills on time.
You can benefit from their smart financial habits even if you never use the card yourself.
Some savvy parents actually add children to their cards to help them build credit from a young age.
Ask your family member to add you as an authorized user on a credit card that has been open for at least a few years and is in good standing.
However, because the primary cardholder will be held liable for your spending, you need to establish rules about how you will use the card.
You might agree to only use the card for emergencies, for example.
If they worry you will hurt their credit history, they don't even need to send you the credit card.
Your credit score will get a boost because of their good behavior.
Writing in Forbes, Rob Berger tells how he added his college-age children to his credit card.
After six months, he was surprised when his kids started getting offers for cards that require good credit:
"Our children now sport a FICO score of about 735. Becoming an authorized user to build or improve your credit score works."
10. Smart financial habits start with a budget
You get into debt because you spend more money than you earn. You rely on credit rather than cash to pay basic expenses.
To avoid getting into debt, you need to track and control your spending by creating a budget.
Tracie Fobes, who blogs under the name Penny Pinchin Mom, says that when she and her husband first examined their expenses, it brought her to tears initially, but ultimately helped her recon with her financial reality.
For those who don't even know where to start, Fobes created a beginners' guide to budgeting:
Compile financial receipts and documents. Keep a dedicated folder or box for pay stubs, bank statements, loan information, and credit card and utility bills.
Determine your income. If you have multiple revenue sources, figure out your monthly income after tax average.
Calculate your fixed expenses. These include car insurance, a mortgage, rent, etc. Add them up and put aside the required amount at the start of each month.
Calculate discretionary expenses. These include food, gas, utilities, clothing, etc. These are a bit more difficult to calculate and might take a few months to determine your average.
Determine your budget. Subtract your expenses from your income. The amount should be zero. If the number is negative, you're spending too much. If it's positive, you could be saving or paying off more debt.
Although it's hard to devise and stick to a budget, doing so puts you in control of your finances. By reducing spending and paying bills each month, you're on the way to a great credit score.
A great credit score is within your control
You might be feeling overwhelmed right now. I know I was when my wife and I sat down and assessed our credit.
It was simple: we needed to get our credit back under control.
She was working on a law degree and could not work. That, coupled with a lower credit score, kept us from getting our new dream car.
I was so set on launching my own business that I didn't want to admit something like credit could stop me. Thankfully, Sarah was so supportive and we sat down and worked out a budget plan together.
Our credit scores rose, our bills started to disappear, and we eventually got that dream car. But not without some serious dedication and work.
Ready to start increasing your score too?
Start by checking your free credit report and seeing where you stand.
Have you struggled with a bad credit score?
What was the one thing that helped you fix it?
Let us know in the comments below.