Do you have a low credit score? If so, you’re not alone. Thousands of Americans, buffeted by the recession, are facing lower than average FICO scores. Since most Americans have, on average, a credit history of 14 years and 13 credit obligations, the capacity for error can be great. In fact, since the average American has approximately $19,000 in credit to manage, it helps to know how you can avoid getting lower credit scores, or how to improve your existing one.
In this article, we discuss how bad credit happens and what steps you can take to repair your low credit score.
How Bad Credit Happens
More than 25% of Americans have credit scores below 600, which is commonly referred to as the dividing line between good credit and bad credit. How do they get into this predicament?
There are four steps most consumers take on the road to poor credit:
- Overuse of credit – the higher your balance, especially relative to your credit limit, the lower your credit score will be.
- Late payments – a single late payment (over 30 days late), can dock your credit score by as much as 110 points.
- Debt management tactics – short sales, deeds in lieu of foreclosure, settlements, and other debt reduction practices can decrease your credit score by as much as 85 to 160 points. Bankruptcy can drop your score another 130 to 245 points.
- Actions by the credit card issuer – your credit scores will fall if your lender cuts your credit limit or pursues any collection activity.
Understanding Credit Management
It’s important to know there’s a right way and a wrong way to manage credit. Less than 50% of Americans have ever been 30 days late on a payment, but 30% have been 60 or more days late, and 20% have had an account closed by the creditor. So obviously proper credit management practices should be implemented by at least half of all consumers who are using credit.
Credit utilization in the United States breaks down in this way:
- 40% of credit holders carry less than $1000 balance on their accounts;
- 48% carry approximately $5,000 or less as a balance;
- 37% carry less than $10,000 in non-mortgage related debt;
- 15% carry more than $10,000 in debt.
Repairing Credit – What You Should Know
You can repair your credit score by taking the following actions:
- Pay all your credit card and other bills every month;
- Begin paying down your high credit card balances;
- Exhaust all other avenues before allowing foreclosure to happen or declaring bankruptcy.
Repeatedly requesting your credit report can lower your score. Be sure to challenge any false or incorrect information on your credit history, which you can obtain by getting your free credit report on an annual basis. The total amount of credit you have isn’t really what counts; instead, lenders look at your available credit when calculating your score. If you want to repair your credit, a debit card won’t help your score, but it can help to rein in your spending habits.
Mortgage rates are determined by a number of factors, including market conditions, your personal credit history and the size of your downpayment.
One of the biggest factors in the mortgage rate you get as a homebuyer is the Federal Funds Rate, an interest rate determined by the Federal Reserve that affects inter-bank loans and transactions. The Fed may lower or raise the interest rate, depending on the state of the economy. This has a great affect on the interest rate the banks are willing to provide to individual mortgage lenders. Mortgage rates are also influenced by the stock market and the effects of the larger economy in general, just as the best savings rate for a savings account is.
Another factor that will affect the mortgage rate you’ll get is supply and demand. If a lot of people are looking to buy homes and take out mortgages, mortgage interest rates will rise. If less people are taking out loans, generally interest rates will fall.
In terms of applying for a loan, your own credit history also has a large bearing on the interest rate available to you. The better your credit rating, the lower your rate will be. If the bank determines you to be a riskier borrower, you may only qualify for a higher rate. They’ll also compare savings accounts you hold with your credit rating to see if you’ll be able to afford a mortgage.
However, down payment can have a big impact on the rates available to you. Even if you have unstable credit, a bigger down payment of, say, 15% to 20%, can go a long way to lower your interest rate on a mortgage for bad credit borrowers. A big down payment is always a good idea, and there are also flexible mortgage plans of different lengths that can affect your interest rate.
As you can see, there are a number of factors that determine mortgage rates, and some of them are beyond your control. If you’re looking into refinancing a home loan, make sure the new rate is low enough to justify any additional costs of refinancing the mortgage. Keep tabs on the economy and do some mortgage rate comparisons, and determine when the optimum time to buy is, and you’ll be in good shape to get the best deal on buying a new home or refinance a current mortgage.
Your credit history is more important than ever. But do you know how to clean it up and keep it looking good?
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Myths About Credit Scores
A reader sent us a question about their credit score, wanting to know why it was lower than they thought it should be and what they could do to bring it up, so I thought I’d answer this reader’s question here for anyone else who may have the same question about their credit score.
There are some myths about credit scores.
Myth No. 1: You have to be in debt to have a good credit score. This is a big misunderstanding.
People with scores above 800 have less debt than those with credit scores of 600 and 700. To get those perfect scores, they did everything right. Credit card bills were paid on time 99.9 percent of the time, their credit cards were older and they had a lot of cards but not a lot of outstanding debt on those cards. That last factor is called a credit utilization ratio. You look at how much money you have access to versus how much of that money you are using.
Ideally, you should never use more than 30 percent of the credit you have available to you. People with perfect scores have an average of 6.7 credit cards, but they obviously weren’t maxed out or even close. The average age of those cards is 10.24 years.
Suggestion: Get several cards and use them for the things you would normally buy, then pay each card off monthly. By doing it this way, you don’t overspend, you don’t get in debt, and you make yourself a valuable credit card customer. You’re showing that you have an active account that you can manage responsibly.
Myth No. 2: Wealthy people have better credit scores.
Income is not a factor in credit scores. Rich people don’t always pay their bills on time.
Myth No. 3: If you don’t have a credit history, your credit score will be poor.
Actually, no credit history means no negatives that can affect your score. You’re given the benefit of the doubt, and you’ll most likely start with a score in the 600s. After that, your score will go up or down depending on how you treat credit. Those whose scores are in the 400 and 500 range are not paying their bills and have otherwise shown a history of not handling debt responsibly.
If you do have a low score, it’s possible to raise it by 100 points or more in just a year if you:
- Clear up any outstanding debt and get current on your payments.
- Make sure all future bills are paid on time.
- Start establishing a new, better credit history by getting a secured credit card, which requires a cash deposit. That deposit acts as the credit line for your account. For example, if you put $500 in the account, you can charge up to $500.
Myth No. 4: It’s better to have no debt at all.
Sounds great, doesn’t it? Unfortunately, we live in a world where people need proof they can pay their bills and handle money wisely. Your credit score is used for many things by many people. In most states, auto insurers can use your credit score when figuring out how much insurance you should pay. Potential employers look at it to see if you’re under financial stress, which could affect job performance.
At some point, you’ll want to buy a house, and a good mortgage loan depends on a good credit score.
You say, you’ll rent all your life? Landlords look at your score as well. So do mobile phone companies.
Get a few cards, use them and pay them as suggested above, and then pay cash the rest of the time. Then, when the time comes and you want to buy that house of your dreams, you’ll have the good credit you need to obtain a favorable mortgage.
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