From the day I began working in college admissions, to the second I started helping distressed real estate clients and all the way up until my last financial crisis client a week ago, I have seen some credit reports that would curl your hair. And despite the fact that my depiction of consumer credit might sound bleak and dismal, it is (in fact) anything but.
Credit is cyclical. Your credit score rises and falls based on your spending habits. And whether you realize it or not, it is much easier to rehabilitate your credit than what you might think at first glance. If you want to go from zero to hero on your credit report, all you have to do is make a few right moves, sprinkle in a little consistency and add a dash of patience.
Know Your Balances
A major contributing factor to your credit score is how much revolving credit you have versus how much revolving credit you use.
I tell my credit challenged clients to keep their revolving credit usage below 10 percent.
For example, if a client has a credit card with a limit of $300, a personal loan for $5,000 and another credit card with a $500 limit, that client should never have a balance higher than $580 between those three accounts. And yes, collection accounts and judgments make up a large part of this. I tell my clients to settle these accounts if they are under four years old.
Naturally, as you improve your credit and, as are able to qualify for higher credit lines, this becomes an easier ratio to hit. But if you are carrying a balance threshold over 10 percent, the best thing you can do is put a maniacal focus on paying your debt down quickly.
Pay It Off Each Month, Every Month
I tell my clients that while it is perfectly acceptable to have more than one credit card, they need to focus on using only one card at a time. I also instruct my clients to pay off that card in full before the grace period expires (usually between 21 to 30 days).
A big part of your credit score is comprised of how many cards (and loans) have balances on them, in addition to how high those balances are. The fewer you use, the better your score.
Let Good Debt Sit
Old debt is not necessarily bad debt. In fact, leaving old (but good) debt on your credit report can boost your credit more than you might think. Old (but good) debt establishes a solid payment history to creditors. And since your credit report is made up of not only how much debt you have now, but how much debt you have had (and paid off responsibly) in the past, aged accounts with a good payment history account for a lot.
I tell my clients to leave all positive data on their credit report alone, and only focus on the less than stellar items.
Stay On Top of Your Credit
You can't fix items on your credit report if you don't know what your credit report says on a regular basis, but credit monitoring solutions can feel like a waste of money. While it's important to monitor your credit reports, it is entirely possible to do it yourself, using a few tricks and helpful reminders.
I tell my clients to order one credit report each quarter from the free annual credit report website. For example, in January, I have my clients order their Trans Union report. Then, in May they would order their Experian report. Finally, in September, my clients order their Equifax report. Since most bureaus report similar data, this is a cheap and effective method to monitor your credit on you own. However, in order to do this on a regular basis, you have to set up reminders.
I use my Outlook calendar to set up regular, recurring reminders for me to practice what I preach. Since I handle most of my personal finance matters on Saturdays, setting up a recurring message to check these items on the first Saturday of each month works just fine for me.
To monitor scores in addition to reports, I direct my clients to the Credit Karma website, and tell them to sign up for a free account. From here I instruct them to set up a monthly reminder to update their credit scores -- and yes, I do the same. Keeping up with your credit makes a big difference, and helps you avoid costly errors and erroneous mistakes.
Weigh Savings Versus Debt
Some of my clients try to bite off more than they can chew financially by simultaneously chowing down on their debt while trying to put more money in the bank. Instead of focusing on saving more now, figure out how much it's costing you to toss money away on interest and focus on your high-interest debt instead of boosting a low-yield savings.
For example, if you have a car payment sitting at 12 percent APR, start plugging money toward your car in order to get the balance down. Then, after six months of good payment history, try refinancing to a lower rate.
What you save in interest today is money you can put in your savings much sooner than waiting to pay off debt and save at the same time. Don't waste money to save money. That's just silly.
The primary ingredient for a good credit score is month after month of plain vanilla on-time payments -- and paying more than the minimum each month is also a plus. If you follow these five steps, they will lead you to credit success in two to three years, no matter how bad your credit might look right now.
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