Do you have a poor credit score of 500 or below? Then you may not realize this but you’re wasting money because you’re paying higher interest rates and higher insurance premiums. If you want to rent a house or apartment you may find it tough because of your poor credit score. And if you decide you’d like to buy a house you may find it impossible to get a mortgage loan.
Pay no attention to them
Have you seen or heard ads promising to get your credit score improved overnight? Well, pay no attention to them. Here’s the very bad news. Improving your credit score isn’t a sprint. It’s more of a marathon. In fact, it could take you several years of diligent work before you saw any real improvement in your score.
Understanding how it’s calculated
Do you know how your credit score is calculated? Our guess is that you don’t. So here’s the answer. Your credit score is calculated based on five components. The most important of these, which accounts for 35% of your score, is your credit history or how you’ve used or misused credit. There’s not much you can do about your history because it’s history.
The next most important component used in calculating your credit score is your credit utilization. This is expressed as a ratio. You can calculate yours by totaling up all of the credit you have available and then dividing it into the amount you’ve used. For example, if you have $6000 in credit available and have used $2000 of it, your credit utilization would be 33%, which is okay. However, if you calculate your credit utilization ratio at 40% or higher this is one of the reasons why you have a poor credit score.
Improving your credit utilization
Here’s an area where you could make an improvement. The two ways to improve your credit utilization is to get new credit or pay down your debts. While you might be able to get new credit it would be better to pay down your existing debt, which could take some time. Suppose you owed $7000 yielding a credit ratio of 70% (total credit available of $10,000). If you could pay down that $7000 debt at the rate of $300 a month, it would take you at least 10 months to get that debt paid down to less than 40% where you should then see some increase in your credit score.
The third component used in computing your credit score is the length of your credit history. It’s calculated based on how long you’ve had credit and how long it’s been since your last action. This is another one you can’t do much about. If you’ve only had credit for three years, then your length of credit history is basically three years.
The final two
The final two components in your credit score is your credit mix and what’s called “other factors”. Each accounts for 10% of your credit score.
Your credit mix is the different kinds of credit you have. What lenders want to see is that you have a good mix of revolving credit and installment loans and that you’ve managed them sensibly. You might be able to improve this component by getting some new types of credit. Of course, you shouldn’t use any of it as this would have an adverse effect on your credit utilization.
Be sure to get your credit reports
If you haven’t seen your three credit reports recently – or ever – you need to get them. They’re available free from the three credit bureaus (Experian, Equifax and TransUnion) or on the website www.annualcreditreport.com. If you read your reports carefully you’ll have a better understanding of why your credit score is what it is. You may find late payments, defaults or even accounts that were sent to collection. You could also find errors in your credit reports that are hurting your score. You can dispute any such errors by sending a letter to the appropriate credit bureau along with whatever documentation you have to prove the error. Getting errors removed from your credit reports could improve your credit score depending, of course, on what else is in your reports.