The Consumer Federation of America recently released results of a national survey revealing that many Americans have dangerous misconceptions about how credit scores affect their financial well being.
Four out of five respondents knew that a score of 700 is considered good but only 22 percent realized that a low score, compared to a high one, could increase the cost of an auto loan by more than $5,000. (The FICO score, the brand of credit score used in more than 90 percent of consumer-credit decisions, typically ranges from a low of 350 to a high of 850; good scores begin in the mid-to-high 600s.)
A significant minority of survey respondents also didn't know that a variety of businesses—not just banks—use the scores in decisions that can affect them financially, the CFA reported. Forty-seven percent, for example, didn't know that electric utilities might use credit scores to determine how big a deposit customers must make when signing on for service.
Raise Your Credit Score to Save Money
For these reasons, if your score is lower than you'd like, make an effort to improve it. But depending on the reason for the poor score, it could take 12 to 24 months to improve, notes Bruce W McClary, vice president of communications at the National Foundation for Credit Counseling, a group that represents nonprofit credit counseling agencies.
You can speed up the process by enrolling in a debt-management program and consistently maintaining on-time payments, "but there’s no instant fix," he says.
Here are the steps you should take:
- Pay your credit card and other bills on time. Thirty-five percent of the FICO score is determined by your payment history—that is, how often you pay on time. It's better to pay the minimum each month than fall behind.
- Check your credit reports. Request one free credit report from a different reporting agency every four months through AnnualCreditReport.com. “Hard pull” credit inquiries—from a potential lender and others with permission from you—can lower your scores slightly but there’s no penalty for checking yourself.
- Don’t apply for multiple credit cards at once. Unlike applying for a mortgage, auto loan, or student loan, applying for several credit cards generates multiple "hard pulls" about your credit history and can hurt your score.
- Don’t open too many new credit accounts at once. By doing so, you reduce the average “age” of your accounts, which can lower your credit score.
- Don’t cancel unused cards (unless they carry an annual fee). Part of your score depends on the ratio of credit used to total available credit. Eliminating a card reduces your credit line and can raise the ratio, which works against you.
- Keep credit balances low. Maintaining a revolving credit balance under 10 percent of your total available credit is wise. A higher ratio indicates an elevated credit risk. "If you use your entire limit or close to it, your ratio will reflect negatively, which in turn will negatively affect your credit score," says Katie Ross, education and development manager for Boston-based American Consumer Credit Counseling, a nonprofit that offers guidance to consumers.
- Maintain a variety of credit types. Successfully paying, say, an auto loan, a student loan, and credit card bills over the same period shows that you’re able to juggle different types of credit. That accounts for 10 percent of your score.
- Pay off debt in collections. The most current versions of the FICO score ignore collections with a zero balance.
- Beware of keeping high balances. If you charge everything on your rewards card for the points, for instance, switch to cash or a debit card for a couple of months before applying for new credit. Lenders can’t tell from your score whether you pay your balances in full every month. But they’ll see from your credit score, a snapshot in time, that you’re charging a lot relative to your credit limit. That can be viewed negatively.
- Get a personal loan to pay off credit card debt. You can improve your credit score by paying off your credit card debt by taking out a personal loan. The interest rate on the loan will also likely to be lower than credit card interest rates.
- Get a secured credit card after bankruptcy. If you’ve been through bankruptcy, start populating your credit report with good credit. Using a secured credit card (that's linked to a bank savings account) may be an effective way to rebuild your credit. A bankruptcy will have less impact on your score over time as long as you aren’t defaulting on new loans. Keep in mind, though, that Chapter 7 and 13 bankruptcies stay on your credit report for 10 years.
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