1. A Little History: In the past 20-30 years, as credit cards have become more abundant, and lenders have competed for loans, decision-making had to be done more quickly and more impersonally. Thus, credit scores were developed that showed lenders, with some degree of accuracy, the amount of risk that they were taking when they loaned a particular individual money. The more risk, the more likely that they would turn you down or charge you higher interest for a loan. This way, they could either avoid a risky debtor or make more money in return for taking a greater risk.
Understanding that basic aspect of credit-worthiness will help you to know the most important factors about your credit: the more overextended you are and the historical facts about how you pay off debt tell a lender what you are likely to do with the new debt that you are asking for from them. That is the theory behind credit scores. Thus, if you want to fix your credit, you need to create a better history and have less debt. A better credit score is an ally in keeping down your debt: the better your scores, the lower your rate.
2. The Credit Reporting Agencies: The three major credit-reporting agencies are Trans-Union, Experian and Equifax. The three companies are essentially repositories of financial information about you. If you have taken out any kind of loan at all, the loan is usually reported to all three agencies on a monthly basis. The agencies report that information to people making inquiries: potential employers, landlords, lenders and even those folks who send you the unsolicited requests for credit. The information included about loans you have or have had in the past generally includes the limit of the credit, the highest balance, the current balance, and your payment history.
The agencies also report your personal information including your address, your employment, and, depending on the agency, how long you have lived at your current address as well as your former addresses. The report will also disclose recent requests for credit. While a credit report can be somewhat complicated to read, the agencies often group information into categories of negative, positive and/or neutral factors in your credit report.
3. Your Credit Score: According to Experian, a credit score is a “number lenders use to help them decide: ‘If I give this person a loan or credit card, how likely is it I will get paid back on time?’” A credit score is generally a number between 200 and 800 and is created by a company called Fair Isaacs (hence, it is often called your FICO score), although there are other models for credit scoring in which a lower number is better than a higher number. Experian has claimed to have joined forces with the other credit reporting agencies to create what it considers to be a more consistent scoring model deemed the Vantage Score that will be a number from 1-1000 based on a series of factors that are similar to the factors in the FICO scoring system.
It is hard to tell yet whether or not Vantage will be widely adopted and replace the other models for credit scoring; however, whatever model is used, eventually you will be rated based on how you have performed with credit in the past. Hence, if you have little or no credit history, you will be deemed a fairly high risk because there is no way to predict your future. If you have a credit history with a number of negative factors, you will also be deemed a high risk. On the other hand, your scores will be good if you have a history of on-time payments and are not currently at or near the limit of most of the credit available to you.
4. What Factors Affect Your Credit Score: The exact amount that any one factor will impact on your score seems to be as closely guarded a secret as the Manhattan Project (the original making of the first Atomic Bomb). However, due to both federal law and out of necessity, a number of factors have been disclosed which explain what goes into your rating. The companies will not, however, tell you how many points one single item is worth. Regardless of whether it is a FICO score, Vantage or some other score, the factors that are important to lenders are similar.
The single most important factor in assessing your credit is your payment history: Late payments of thirty days or more are reported to the credit agencies and decrease your rating significantly. The other area that gets tremendous weight is your use of your credit: if you are at or near the credit limit of most of your revolving credit, your scores will be significantly impacted.
Beyond that, debts which are either in collection or listed as charge offs (a debt that the company has decided will not be paid by the debtor) will have a significant negative impact as will bankruptcies, liens and judgments against you (although interestingly, many people have found that they can easily rebuild credit approximately two years after a bankruptcy filing because they cannot file again in the near future). Finally, almost all models of credit scoring will consider recent requests for credit on your report as an adverse factor. Some requests for credit made at or within two weeks of one another and for the same type of credit are treated as one inquiry for your score so do not worry if you are attempting to get a big ticket loan and want to shop around for the best lender – all requests will be considered as one. Also, the unsolicited credit offers will not impact your score unless you follow up and actually ask for the credit offer.
5. How You Can Improve Your Scores: You can improve your scores by insuring that incorrect or outdated information is removed from your reports. This requires you to contact all three credit-reporting agencies to request your reports, review them, and then write to them to them to fix or remove inaccurate or dated negative information. (If there is old information on your report, but it does not reflect negative information, do not remove it – a lengthier credit history is better for your scores). You cannot remove accurate information or information that has not aged out, but the older the information is, the less weight it is likely to have on your score.
It is the creditor’s obligation to prove that the information they have reported is accurate; thus, if you dispute an item, the credit-reporting agency is required to investigate and gain proof that the item is accurate. Some companies that negatively reported will not contest older items and you may be able to have them removed simply by asking. If, however, the information is accurate, and the creditor corroborates the information, it will stay on your report until the time it should expire.
Most negative items expire seven to ten years after the date of the item. So if your report is indicating late payments from before 1999, you should be able to get those removed. Do not expect the credit reporting agencies to automatically redact information (although they should); you need to stay on top of your credit and make sure that they do their job. Much of this work can be done on line.
6. How You Can Find Out What Is In Your Report and Your Scores: Your credit reports and your credit scores are two different things. You can get your credit reports from each of the three agencies for free once per year. The federal government passed a law that made it your right to get one free credit report per year from each of the three credit agencies. That means you can get a free report every four months if you space out your requests. The information for obtaining your reports is located at http://www.ftc.gov/bcp/conline/pubs/credit/freereports.htm. If you have never looked at your report, go on line and get one now. You will need to prove who you are by answering a question about your mortgage or some other loan, so have that information handy.
The report itself will only tell you what has been reported; it will not tell you the scores. Those you will need to buy if you want them. When you go on the government site to get your free report, you will also be asked if you want to pay for your score and/or a credit monitoring service. The monitoring service, which is offered by the agencies as well as by many credit card companies, is generally considered a waste of money. It is usually a monthly fee of anywhere from 10-35 dollars (depending on the service), and offers you very little that you cannot get yourself. Generally, a credit monitoring service will alert you to changes in your credit at or around the time of the change. Their purpose is to let you know if any new accounts are being opened in your name. The tactic such companies use to sell their services is that such a service can let you find out about identity fraud more quickly than if you wait to get your own credit reports. However, most credit cards limit your responsibility to charges fraudulently made on your account, so there may be no reason to accept credit monitoring. Most monitoring, unless you have some particular need for it, is a waste of money.
On the other hand, if you are planning to apply for a loan in the near future, you should purchase at least your FICO score and be prepared to deal with credit issues affecting that score before you apply for the loan. Although credit-reporting agencies are supposed to fix your credit reports within a 30-45 day time period, it generally takes longer to have negative items removed depending on where in the cycle you have made your request.
Some of the problems affecting your score may take some time to fix: for example, if a debt is accurately reported as in collection, and you are going to pay off the date, you will need to pay it, and then it will take anywhere from 30-60 days before it shows as paid. Thus, if you are planning to pay off a debt that is in collection, you should reach an agreement to settle the debt and have it removed from your credit report – many collection agencies are receptive to that sort of deal (as well as settling for less than the full amount owed); however, be sure to write to them with the terms of your agreement spelled out or the debt could be resold to another agency and come back to haunt you and your credit years later. This process could take 60 or even more days before it is off of your credit reports and no longer impacting your score.
If you are planning a big purchase in the next several months, now would be a good time to review your reports and get your scores. After you have asked for disputed items to be removed, the agency will send you another report with an explanation of what they did with your requests and the new reported items. At that point, you may wish to puchase your score again (after a week or two) to see if the actions you took changed your score. Doing so allows you to increase your score before you apply for a loan which will allow you to get more favorable terms. Even if you cannot change your score, knowing your score will allow you to be prepared to deal with the lender rather than walking in unprepared for the truth about your score. It will also force you to make decisions -- you might choose to put off a major purchase, use a different source of funding,finance for a longer period of time, etc. But to make any decisions, you must take control over your credit reports and scores by knowing what is in them.
7. Credit Repair Companies: There are companies who will contact the credit reporting agencies for you and help you to get rid of negative and outdated information. If you feel do not have the time or energy to dispute your own credit reports, or you will not follow up with taking care of negative information, you might want to turn to a credit repair company. Just keep in mind: if you are persistent, you will be able to do anything that they can do legally. Thus, it is not an essential service by any means. But it is legitimate to seek assistance if you do not want to be bothered by the work of doing this. This service is different from credit counseling: credit counseling can actually negatively impact on your score whereas credit repair is strictly fixing up problems with the credit reporting and should not be reported.
Be careful though: there are scams in the credit repair world, and, if anyone promises that they can get rid of all your negative reporting, they are lying. They can only get rid of incorrect, outdated, or undisputed items. They may also be able to negotiate with companies with whom your prior record was bad to get them to remove negative reporting: you could do that also. Other scams exist in this field. First, some companies can overcharge for the work they are doing. The information is readily available on line, and getting access to credit reporting agencies is not at all difficult – they all have websites and forms that you can download to write to them to dispute information. Some even let you dispute information while you review your report on line. So credit repair companies are not performing miracles and should not be paid an exorbitant amount.
More importantly, though, are the illegal actions that some companies have been suggesting to clients. For example, in one recent scam reported by MSN Money, credit repair companies were getting clients new social security numbers and addresses and creating basically phony credit histories using the new information. They told clients that the use of such repair techniques was routine and legal. Not surprisingly, it is neither routine nor legal. Yet, people followed this advice out of desperation and ignorance. Do not fall into any of those sorts of scams: it is legal to have items removed that are wrong, outdated and/or undisputed. You may also be able to get a company to agree to just remove an old debt because they are no longer working with you and it is due to be removed soon anyway. You can also choose to negotiate with a creditor to whom you owe money to settle the debt. You could pay off a judgment that is outstanding -- any of these legitimate actions can "repair" your credit. Any methods of repairing credit that do not involve dealing with the underlying financial issues should be closely scrutinized.
8. What You Can Do to Get and Maintain a Better Score in the Future: You may not be able to do anything with the items that exist in the past. If they are accurate, you cannot change the past, and they will remain on your credit report and affecting your score for a fixed period of time. With time, however, your credit can become much better if you do things right from here on out: in other words, organize your finances so that you pay your bills on time every single month. If you cannot pay your bills for some reason, contact your creditors and see if they can change the terms or extend the time to pay so that it will not negatively affect your credit.
Also, reduce your outstanding debt so that you are not maxed out on your cards. Even if you pay your cards in full every month, you could negatively impact your credit by maxing them out because they may be reported prior to the date you pay them and you will appear to be maxed out.
Avoid applying for or taking on new credit -- just say no even if it seems like a deal: i.e., you are at a store and about to pay for your purchases when the cashier says that applying for the store credit card will save you 10% on today's purchases, using the card will save you even more. Often, this is not as big a "deal" as it appears to be because it can have a really negative impact on your credit score. Most store cards are from finance companies which is considered by the credit scoring companies bad debt and having it can alone lower your score. Also, you are making an application for credit which will negatively impact your score for at least the next six months and maybe for the next two years. Finally, it is an invitation to further debt: your best promise to pay it off when the bill comes may not happen in whic case the 10% you saved becomes 28% you will pay in interest. Just say no.
Remeber, every time you put in a request for credit or pay your bills late, you have a good shot at decreasing your score for some period of time. So, get organized by organizing your finances, maintaining a disciplined schedule for bill payments, taking care of any problems that you need to take care of as soon as they arise, and reducing or eliminating your debt. Do not take on anymore unnecessary credit and do not make any unnecessary requests for credit. If you live in a more disciplined way, you should see your credit scores go up in the next two years. This is an excellent method for taking control over money.
Below are several helpful links to resources you can use to help you to repair your credit.