Credit. It's the bane of your existence. You start your life without it, build it, and hopefully don't destroy it before you need to make a major purchase. Unfortunately, about 25% of Americans currently struggle with bad credit and are attempting to make a change. The first thing you need to understand is exactly what credit is.
What is a Credit Score?
Your credit score is a number your potential lenders will use to determine your credit worthiness. The major reporting bureau, or FICO, assigns you a number which tells the lenders how risky it might be to give you a loan. The higher your score (up to 850), the better your odds.
There are 5 main factors that go into the creation if your credit score. The biggest issue is your payment history, which makes up 35% of your score. The amounts you owe (30%), the length of your credit history (15%), the types of credit you are using (10%), and whether or not you have new credit (10%) are the other factors. Take the types of credit you have in use, for example. Credit card loans are considered a higher risk than installments loans, car loans, or mortgages.
Why Your Credit Matters
You may be wondering why this matters to you at all. You can, theoretically, live your life without credit, right? Wrong. Maybe in the past, but not anymore. You could theoretically live your life without using a credit card or creating that type of revolving debt, but you will at some point want to buy a new car or maybe even a house. You'll need to have a decent credit score to apply for those types of loans and the banks will definitely pay special attention to your score when determining if they want to give you a loan. If they do, they'll use that score to determine the type of interest rate they're willing to give you and how long they're willing to give you to pay your loan back.
And that's not all. You want to rent a house or apartment? Landlords often look at credit scores to determine if renting to you will be risky. It's especially important to them because of the lengthy process involved with evicting someone who doesn't pay, which can take months. Automobile and homeowners insurance providers feel that people with low credit scores are less likely to make payments and are more likely to file high or false claims. Employers often run credit checks as part of the application process. Even though they aren't supposed to use that information to make a hiring decision, they wouldn't run it if they weren't considering it for some reason (especially in banks and financial institutions).
How to Fix or Rebuild Your Credit
There's been some significant legislation in the past several years, most aimed at helping people get a better handle on their credit scores. Most important for you to understand is that you have the right to one free credit report each year. You should be ordering your report annually, checking to make sure any closed or paid accounts are marked accordingly, and making sure all of the numbers are correct. If you find mistakes, you need to send letters to the reporting bureaus, with supporting documentation, to have the mistakes corrected. Once the mistakes are corrected, the reporting bureau will send you a statement in writing along with another free copy of your report (this corrected report doesn't count against your 1-free-per-year report).
Other things you can do to make sure you're credit is in tip-top shape? Start by making sure you're paying your bills on time. Late bills are reported to the credit bureaus once they are 30 days past due, so even if you're late, make sure you're paying within that grace period window.
Since credit cards are most damaging and sensitive, make sure you focus on paying those off first. You'll be killing two birds with one stone, moving the volatile accounts off of your list of debts wile lowering your debt to income ratio. Once your credit card accounts are back in order, make sure you only use them sparingly. Your utilization ratio should be under 10%, for the most part. That means if you only have a $1,000 limit, you should never have a balance higher than $100.
Finally, try to consolidate your debt onto one card. Doing so will make it easier for you to pay down your debt. Don't necessarily close the cards that no longer have balances. Leaving them open will help your utilization ratio overall.
While you may prefer to live a life without credit, not paying attention to your numbers will probably haunt you at some point in your life. Take advantage of the tools available to you and take care of your credit before you actually need. it.
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