Key Take-Aways
- A low credit score can have a large financial impact
- Increasing your credit score can help get access to better and cheaper financing
- Though credit repair might seem like an impossible task, it can be done within 3 to 6 months for free, without any costly program’s
- Pulling your credit report and creating a plan of action around your specific situation is key to your success
- Automate and use free tools such as Experian Boost and Personal Capital to monitor your progress and help develop good financial habits
Low Credit Score Can Cost You Big Money
A low credit score can be the result of several different reasons, such as late payments, over-utilization of a credit card, no credit history, or outright errors in your credit report. Regardless of the reason, a persistent low score can cost you big time in the form of higher interest rates when applying for a new line of credit. Even worse, a low credit score can keep you from getting your next apartment or getting approved for a mortgage for the home of your dreams!
Raising your credit score can seem like an impossible task, but there are proven ways to increase your score within 3 to 6-months. And, to make things better, you do not have to pay for or enroll in any pricey programs; you can increase your credit score by yourself in 6 simple steps!
What Makes Up A Credit Score
Before jumping in too deep, it is important to understand how the three big credit bureau—TransUnion, Equifax, and Experian—calculate your credit score. By understanding the different categories that make up your score, you are better positioned to take the necessary steps that have the largest impact on your credit score. With that said, here are the 5-categories, and their respective weights, that make up your credit score:
- Payment History: 35% – This category has the largest impact on your credit score. Making timely payments and paying off any overdue items help improve this area of your credit.
- Amounts Owed: 30% – This category is also commonly known as utilization rate. This represents your total revolving balance divided by your total credit limit—summed for all credit accounts. Lower is better. You can improve this by paying down any lines of credit where you are close to the maximum offered.
- Length of Credit History: 15% – Credit companies like to look at the age of your oldest and newest credit accounts as well as the average age of all credit accounts for an individual.
- New Credit: 10% – Generally speaking, applying and opening several new lines of credit in a short period hurts your credit score.
- Credit Mix: 10% – Credit companies typically like borrowers with diverse types of finances, such as credit cards, auto loans, and installment loans. Luckily you don’t need one of each!
It is important to note that the relative importance of the different categories listed above varies from person to person. For example, someone with a short credit history will be scored differently than someone with a long credit history.
Six Steps to Increase Your Credit Score
Step 1: Getting Your Credit Report
The first step in improving anything is understanding where you stand now compared to where you want to be! The same is true with improving your credit score. Luckily, Federal law requires that the big three credit reporting agencies provide consumers with a free annual credit report, which you can get at www.annualcreditreport.com.
Shortly after making the request, you will receive a copy of your latest credit report, and you should look for:
- Late or delinquent accounts: Given that payment history is the largest part of a person’s credit score, it is critically important to resolve these items first. If paying them off is not possible, contact each creditor to find out what is the minimum amount you need to pay to become current.
- Errors in your credit report: Identify any errors or discrepancies on your credit report and quickly dispute them. This can be done with free tools such as www.dovly.com. This is also a great time to review for any signs of identity theft such as credit cards you do not recognize.
- Category Identification: Using the 5-major categories reviewed earlier, note what areas are most impacting you. For example, you might see that you have applied for and opened more than 2-lines of credit over the last 12-months, or your credit utilization rate is high. Whatever it is, note what is impacting you.
Step 2: Formulate A Plan
If you finalized step 1, you now have a firm understanding of what areas of your credit report are having the most impact on your credit score. If you saw that you have not opened or applied for any new lines of credit over the last 12-months, then you know that is not something you have to worry about when it comes to improving your score. Alternatively, if you pulled your credit and found you have no reported lines of credit, then a different plan of action is needed. And finally, if you found you have a high utilization rate, then a good plan would start by inventorying every line of credit and noting the balance, minimum monthly payment, and interest rate.
Addressing Lack of Credit History
If you found that you have no reported lines of credit, then an easy fix is to get a credit card. There are cards catered to folks with different credit backgrounds; for example, there are beginner cards for people with no credit history. Alternatively, there are secured credit cards that are perfect for people trying to rebuild their credit. Banks, such as Bank of America, offer credit cards where you provide a deposit of $300 to $500 that the bank then uses as collateral on a credit card extended to you. Sure, you are effectively borrowing your own money; however, your payments are reported to the credit agencies and help build your overall credit profile.
Addressing high utilization
If your credit report showed a high utilization rate or large-revolving balance, paying down your debt is key. Once you have listed out your debts, you can choose a debt paydown strategy that works best for you. The three most popular paydown strategies are debt snowball, debt avalanche, and debt consolidation. The below table provides an overview of each.
| Strategy | Overview | Pro’s |
| Debt Snowball | Tackle your smallest debt first, while paying the monthly minimums on all other debts. Once your smallest loan is paid off, apply all that money to your second smallest loan. Repeat until all debts are paid off. | Creates a lot of quick wins, and helps you build confidence in eliminating your debt. |
| Debt Avalanche | Tackle your largest and/or highest interest rate debt first while you pay the minimum payments on all other debts. Once you pay off the first loan, use that money towards paying off your second largest loan. Continue until all loans are paid off. | Paying off your highest interest debt or largest loans will result in the largest interest savings. Additionally, since these are the largest loans, paying them off will have the largest impact on improving your credit score. |
| Debt Consolidation | Combine all debts into a single account, and many times this can be done while lowering your overall interest rate. | Rolling all your debts into a single account allows you to focus on a single payment. Additionally, if you can refinance your debt at a lower rate, you will end up saving on interest expenses. |
Step 3) Automate Your Plan
After categorizing your areas of improvement, and formulating a plan around those areas, you need to automate as much of your finances as possible. If you are paying down debts, schedule your payments according to your plan and have them set as automatic recurring payments. If you are opening a brand new secured credit card, enroll in automatic payments. These crucial step helps solidify your intentions and remove the risk of forgetting to make a payment or not sticking to your payment schedule.
Step 4) Budget
Realistically, scheduling payments and debt snowballs are of little use if you don’t have any money left over after each paycheck. To this end, there are two very simple ways to address the problem: increase the income or decrease the spending. Admittedly, both are easier said than done, and both should be pursued aggressively; however, the thing most in your control is spending, so we’ll focus on that here.
When it comes to budgeting, it can be as complicated or as simple as you like, but I have found that simple beat complex almost always. I’m personally a fan of the ‘50/30/20’ approach, where 50% of your take-home pay goes towards needs, 30% towards wants, and 20% towards savings. Now that is great if you have all your finances in order, and your credit score and debts are already sitting pretty. I would say if you are trying to get caught up on outstanding debts and trying to drive down credit card utilization, then the 30% going towards ‘wants’ should be reduced to 5%-10%, and use the difference exclusively on eliminating debts and reducing credit card utilization to increase your credit score.
On a personal note, there was a time where I lived in my car for a short period simply to reduce my fixed expenses so that I could focus on paying off student loans and minor credit card debt. I was making $12 an hour and the math was clear. I could not realistically tackle my nearly $1,000 in monthly debt payments, so I made the hard choice of living out of my small car while I aggressively paid down debts, and continued looking for a better paying job (spoiler alert, I found a better paying job).
What about savings?
This is a very common question that arises when it comes to tackling credit card debt, or any other type of debt. Should you continue putting money away while trying to pay off high-interest debt. The answer varies from person to person, and it is ultimately a personal choice, however, many financial experts agree that continuing to save some funds into an emergency fund is still a priority even while paying down debt. The reason is simple, in an emergency, if you don’t have an emergency fund you will likely tap credit cards to get by and this will only put you further in debt. If you have an emergency fund, you can leverage that instead and not add to any existing debt. That said, many suggest focusing on the minimum amount needed to handle a bump in the road. As a result, instead of savings with 3 to 6-month’s worth of expenses, you settle for 1 month worth of reserves and focus on debt paydown with the rest of the money. Additionally, the decision should be informed by the interest rates of your debt. For example, if you have debt with an APR north of 19%, paying off that debt first would be most beneficial.
To learn more about an emergency fund read this post.
Step 5) Monitor
With a budget in hand, payments, transfers, and other financial activities automated, the last major ‘to-do’ is to monitor your progress. At this stage, you want to closely monitor your credit score and your household balance sheet. Luckily for both of these items, there are several free tools to help you track and monitor your progress.
As the goal is to increase your credit score, that will be a key thing to keep tabs on. Now, you can only get an official free credit report once a year from each of the credit companies, but you can sign up for services like Experian Boost that provide ‘soft’ credit checks and provide you with an estimate of your current score. Alternatively, several credit cards also have free credit score monitoring services built-in, and they will provide you with monthly estimates of your credit score.
Monitoring your balance sheet and overall net worth is key to ensuring that you are continuously moving in the right direction. Free services, such as Personal Capital, allow you to easily connect all your financial accounts in one place and quickly monitor your spending vs income over time and drill down into different categories to see where your money is going. Additionally, Personal Capital provides an easy way to monitor and track your net worth over time. Such tools not only help you stay on track as you work to improve your credit score, but they help you build long-term positive financial habits.
Step 6) Become An Authorized User (BONUS step)
This item is saved for last because it is not an option for everyone, and it alone will not help you build a good credit score and good financial habits. That said if you have a spouse or close family member with good credit, you can ask them to add you to their credit card as an authorized user. This will provide a quick boost to your credit score, and you can continue to benefit from their strong credit history so long as they continue to make payments.
Two important things to note about this. The first is that this only works if the lender reports authorized users to the credit bureaus; it’s best to do some research on your own before asking your spouse or family member. Second, this is a one-time boost that happens within the next credit reporting period cycle.
Conclusion
A low credit score can happen for a variety of reasons, from lack of credit history, past due accounts, or outright inaccuracies. Whatever the issue, a low credit score can cost you money in the form of higher interest rates, and a low score can be holding you back from your next auto loan or mortgage. Luckily, repairing your credit is entirely within your control, and can be done within 3 to 6 months for free, without having to pay for any credit repair services or consultants. Regardless of your situation, the first step in improving your credit is pulling your free credit report at www.annualcreditreport.com to understand where you are starting from, and assess which of the 5 credit categories is hurting you. Once you understand what categories are impacting your credit score, you can create a plan of action, automate your finances, budget, and finally monitor your progress by using tools such as Experian Boost and Personal Capital. Lastly, for those with a spouse or family member with strong credit, you can ask to become an authorized user of the account to get a quick boost in credit. Following these steps will not only improve your credit score but also build good financial habits that will help you take control of your financial future.
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