With the American economy still not firing on all cylinders, unemployment at very high levels (the rate only seems to come down when people have received the maximum number of weeks’ payments and fall out of the workforce altogether), and no sure signs of economic recovery imminent, it doesn’t surprise me that one of the topics that I talk about with people on a very regular basis is how to rebuild credit scores after a period of unemployment and falling significantly behind on debt obligations. I don’t have any data to support this, but it seems like the average credit score of all Americans has probably dropped 100 points or more in the last several years. (I think I just found a weekend research project for myself. Yep, I just might need a hobby.)
Because of all of the conversations I have had on this topic, I asked a number of people who are involved in the banking, consumer finance, and debt counseling arenas for their thoughts on some very simple, “back to the basics” things people can do to help improve their credit scores. Here are some of their ideas along with some commentary:
1. Understand where you are. The first step is often just getting a grasp on where you are today. Order your credit reports to see what is on there. So many people intend to do this, but never get around to doing it. Check it out to make sure everything on there is yours. I have found AnnualCreditReport.com to be very useful. Also, you can track your credit score at CreditKarma.com. Both of these ideas cost you nothing, they are free. (My favorite 4-letter word. Maybe tied for 1st with food?)
2. Know where your money goes. Whether it’s tracking your spending in a notebook, reviewing your bank statements, using a software program or an online service, you should know how much you spend and exactly where it goes. When you know this, you gain an added measure of control over your budget and can begin to set reasonable goals. I use a free service that helps me track expenses, set monthly goals (my budget for eating meals at restaurants is tracked closely and I have set goals to reduce this expense) at mint.com as well as this expense tracker form.
3. Set reasonable goals. You can set goals that are not outrageous like “pay off 1 credit card in the next 6 months” or “start saving $20/paycheck into an emergency fund” that may seem small but can add strength to your financial life. Start there. You can work up to “have a $1,000,000 investment account” later. Make your goals reachable. This calculator can show you exactly how much you need to save each month to reach your goals.
4. This one is obvious, but pay everything on time. This builds months of history, and when you pay this month’s bills on time, a month way in the past where you may have had a late payment falls off of your credit report. Eventually, your credit report will look back far enough so that this month’s payments are the first month that is tracked on your report. An idea here is to use the automatic payment feature, which can be set up with nearly all credit card companies. Personally, I prefer to set this up through my bank so that if I change banks or dispute charges (like in identity theft situations) I can more easily cancel the automatic payment.
5. If you can’t get approved for a credit card, get a secured credit card that reports to all of the credit bureaus. This will help you develop additional months of on-time payments that get reported and increase your score each month. Both CreditKarma.com and Mint.com have areas on their website that can help you shop for the right secured card.
6. Understand what the big factors are in your credit score. The 2 biggest factors are the percentage of on-time payments in your credit history and your “utilization rate.” The percentage of on-time payments is easy to understand. Utilization rate, not so much. Here’s the deal on that. If you have $10,000 in available credit and have $4,500 in balances outstanding, you have a 45% utilization rate. Ideally, you want this number to be at 30% or less to maximize your credit score. So, when a card is pushed toward the maximum line of credit, it hurts your credit score. Most people that I know had no idea how that worked until we talked about it. If you understand how it works, you can figure out how to use that knowledge to your advantage. Paying your balances on time, and more than the minimum payment, will help your balances go down to the point where your utilization rate is a positive for your credit score.
If you’re looking to improve your credit score, there are just a few simple steps to making real progress. Find out where you are and where your money goes. Set some realistic goals and reach them. Understand what is in your credit score (Credit Score Components) and how to improve each factor. It is actually easier than it sounds, and I hope that knowing that it’s not difficult can help you make improving your credit score one of your realistic goals.