Your credit score is one of the key variables that banks and financial institutions use when deciding to lend you money. FICO scores, which are one of the most common types of credit scores, are used in 90% of all American lending decisions. If your credit score is low, it can make it much harder to access loans and credit. This is why you’re never too young to worry about your credit score, as it affects financial decisions later in your life.
The key takeaway is that you can learn how to rebuild credit, but it is a slow process.
How to Rebuild Credit: First Check Your Score
The first thing you should do when looking to increase your credit score is to check to see what it is. There are several companies that offer free credit checks, usually one a year. Checking your credit score can help you see how much you need to improve by – and can also alert you to fraud. If someone else is using your name or social security number, they can ruin your credit without you knowing about it. You can check your credit score without affecting it.
Next, you can look up the basics of how credit companies calculate your credit score. For example, FICO breaks down your score in the following categories:
- 35% is your payment history
- 30% is how much you owe
- 15% is the length of your loans (account age)
- 10% is new credit
- 10% is how mixed your credit is
There are many scams out there that claim that they can increase or protect your credit rating without much effort. The most common of these are services that claim to sell Credit Protection Numbers, or CPNs. You can read more about CPNs and why you should never use them.
Pay Bills on Time
One of the simplest ways you can boost your credit rating is by paying your bills on time. Letting bills sit for a few months before you get to them can hurt your credit score. Additionally, waiting to pay bills off can accumulate late charges and interest. This means that you will end up paying more than you would have otherwise. Catching up on late payments and maintaining a regular payment schedule can improve your credit over time.
Maintain Several Types of Credit (Responsibly)
Paying down the balances on several different types of loans and credit will improve your credit. For example, maintaining a personal credit card, a mortgage, a student loan, and a loan for your vehicle makes you look more responsible in the eyes of credit agencies.
In a similar train of thought to the above point, reducing the size of your loans can help improve your credit. Large credit card debts, mortgages, or car payments can reduce your credit score, especially if they are large relative to your income. However, you should avoid closing credit card accounts or lines of credit once you have paid them off. Closing credit cards and other accounts also increases the ratio of how much you owe against how much credit you have available. Closing the account means it won’t reflect on your credit score.
Avoid Opening New Credit Cards
While opening new credit cards will increase how much credit you have available, which can help your score by decreasing the ratio of how much you owe, it won’t boost your rating. This is because new credit cards and accounts will reduce the average account age you have under your name. Applying to several new cards or accounts at once can also lead to many simultaneous inquiries into your credit score. This can also hurt your credit score.
Restructure Your Debt to Reduce Interest
Another way to improve your credit rating is to take steps to reduce your interest payments. For example, credit cards usually charge a higher interest rate than personal loans or lines of credit. Clearing a credit card (and not using it as often in the future) and moving the balance to a lower interest credit vehicle can provide you with short term relief. It can also make it much easier for you to pay down the balance in the future.
Increase Your Credit Limit
Though this may be difficult to do if you have a low credit score already, you may want to consider raising your credit limit on your personal credit card. This can help decrease the ratio of how much you owe relative to how much credit you have available.
However, if you do increase your credit limit, you should be careful not to max out your new credit limit. An improved ratio only works if you don’t use the credit you have available. Maintain a steady payment plan to leverage the benefit of having more credit available.
Learning how to rebuild credit is half the battle to financial independence. You’ll still need the discipline to alter your spending habits and maintain a payment plan to reduce how much you owe. With enough time, you can get your credit score back to a healthy level. Good credit scores can make it easier for you to access credit for the next stage of your life, from increasing your current available credit to accessing new forms of credit like mortgages and car loans.
For more information about credit scores and personal finance, feel free to check out our blog. Accessing more information about how to maintain your financial health can help you avoid headaches in the future.