It happens. Life happens, bad financial decisions happen, credit card or loan payments are missed, and unfortunately, sometimes bad credit is the result. We get it, but the reality is, your credit score plays a pretty important part in your life.
Bad credit scores mean it is more difficult to get car loans, mortgages, and other loans, and it makes the loans you can get more expensive since the interest rate will be higher to offset the risk of default. Half of all employers use credit reports as a factor in making hiring decisions.
According to Ford Motor Credit Company the interest rate someone with bad credit can expect to pay vs someone with good credit is 2.5 to 3.5 % higher.
What does that mean in terms of cost? On a $20,000 car loan that can mean an extra $1800 over a 5 year period. And for a mortgage or refinance loan it can mean up to 2% higher for someone with bad credit.
Why does your credit score matter?
Your credit score will determine if you will be able to borrow money and how much it will cost you.
Credit scores are rated from 300 to 850. Below are the ranges from good to bad-
Exceptional: 800-850
Good: 740-799
Good: 670-739
Fair: 580-669
Poor: 300-579
Let’s say you checked your credit (which you should do annually, for free from annualcreditreport.com, to make sure all is well) and your score is not great. You are planning to buy a house in a few years, so you are planning ahead, starting with your credit, and giving yourself time to take action. Depending on the reasons for your low credit score, it may take years to fully repair it, but it is best to get started once you know there is a problem.
Your credit report will show you what is affecting your score-late payments, debt usage, inquiries, types of accounts, and credit age. Determine where your derailers are so you can take action.
How is your credit score determined?
35% is from your payment history
30% is from your credit utilization
15% is from your credit history
10% is from the mix of credit accounts you have
10% is from new credit inquiries
How do you improve your credit score?
1. Pay your bills in full and on time-even being one day late can increase your interest rate and result in late fees, and impact your credit report for up to 7 years. I am a fan of putting credit card bills and loans on autopay to avoid any chance of missing a payment.
2. Use no more than 30% of the available credit on a credit card, though less is better. Consider using one credit card-Credit scores are generally higher for people who do NOT max out their credit card. It’s also easier to keep track of spending when you only have to look in one place.
3. Having long credit history indicates you are creditworthy. Old accounts that are in good standing are best.
4. By having an account mix that shows installment loans and credit cards or lines of credit can help your score by showing lenders you can handle both types of accounts. Installment loans are loans with a fixed monthly payment for a specific term (like a mortgage, car loan).
5. Watch the credit inquiries. Hard inquiries are when your credit is pulled by a lender because you have applied for credit. One hard inquiry can lower your score by 5 to 10 points for up to 2 years. A soft inquiry is when your credit is pulled by an existing lender, when you personally review your credit , or for preapproved credit offers. These soft inquiries do not affect your credit score.
How long it takes to repair bad credit depends on just what the reason for the bad credit is. Foreclosure, bankruptcy, bills sent to collection, and even a missed credit card payment, can all stay on your credit report up to 7 years. Hard inquiries will stay on your report up to 2 years. That said, you can take action as soon as you know you have a problem, and you know where that problem is. Your credit score is a truly valuable currency that you can control and that can affect the financial choices you have. Don’t let bad credit history dictate your financial choices!
Last month we covered Tips to Building Your Credit, which offers steps to create credit history. You can find more useful financial tips on the WealthChoice blog.
