Money at 30: 4 Bad Credit Scenarios and How to Fix Them
A few short weeks ago I made my debut on this site by sharing the tale of my financial awakening and how I was now finally taking a serious interest in credit after all but swearing off it for several years. Since sharing that story a few different things have happened. First my research and interest on the topic of personal finance has expanded and I’ve been inspired by several different articles and blogs I’ve come across, even falling down various rabbit holes while looking into particularly interesting topics. The other thing that’s happened is that friends and strangers alike have contacted me asking for tips for their situations and how they too could turn their credit around as well.
The truth is that having bad credit is no fun. In addition to potentially paying more for cars, homes, etc. your poor credit could also affect your ability to rent an apartment or even find a job. Of course not every scenario is the same and it’s important to find the main cause of your credit issues so that you can start to fix them.
With that in mind I’ve come up with four common examples as to why your credit scores may be lacking and will discuss how you can start to improve them:
Maxed out credit cards
Why it’s a problem:
Credit utilization makes up a healthy chunk — 30% to be exact — of your FICO credit scores. Because of this maxing out your credit cards or even bringing them close to their limit can hurt your scores in a big bad way. In fact most experts recommend that you use less than 30% of your available revolving credit, with under 10% utilization being ideal (suddenly that $10,000 credit limit doesn’t sound so high, huh?).
You may have heard the term “debt consolidation” on daytime TV commercials and associated it with being over your head in bills or even on your way towards bankruptcy. While consolidation may be an option in those cases it can also help you raise your credit score even if you’re not in any immediate trouble. That’s because credit utilization only applies to revolving credit, such as credit cards, but not installment payments such as loans.
One popular form of debt consolidation is the use of a personal loan. Basically, instead of making payments on each of your cards individually, you can apply to get a lump sum of cash in order to pay down your credit cards and make monthly payments on your loan instead. This not only provides you with a clear path to paying off your debts but could also help raise your credit score since your utilization will be much lower.
When considering whether a personal loan makes sense for you, you should first compare how much you’ll be paying each month on your loan versus your credit card. Often times a personal loan will carry a lower interest rate but there’s no guarantee of that (especially if your credit really is a mess). To get started use a personal loan calculator to ensure that you won’t be spending more on interest and that you can afford the required monthly payments.
Lastly, even after you pay off your credit cards with a personal loan, it’s important not to close your accounts — something I was unfortunately guilty of doing. This may seem counterintuitive but canceling your old cards can hurt your credit since you’ll have less credit to utilize. Instead leave them open but use them responsibly.
Lack of credit history
Why it’s a problem:
It’s kind of a catch 22: you need credit in order to get approved for loans or credit cards but how can you earn it in the first place? This is a problem many people (especially younger ones) have encountered. So how do you get started?
Did you know that are at least two different kinds of credit cards? Most people are familiar with regular, unsecured credit cards, but there are also secured credit cards. If you have limited or no credit history then getting a secured credit card is a great way to start building your credit score.
What makes secured credit cards different is that you’re required to make a cash deposit up front. Typically this will be up to a couple of hundred dollars depending on the credit limit you’re seeking. From there you just make purchases on your new secured card and pay off the balance each month.
Another option is to become an authorized user on a family member’s credit card (in my case it was my wife who hooked me up with that). This will allow you to not only use their credit account but also potentially earn credit of your own in the process. Just be advised that not all card issuers report authorized users to credit bureaus, while others may have restrictions on who can be named an authorized user. Be sure to inquire beforehand so you don’t waste your time using a card that won’t build your credit.
Why it’s a problem:
Making a late payment can have a lasting negative effect on your credit scores. In fact one payment that’s more than 30 days late could tank your scores by 100 points or more. And, take it from me, those missteps won’t easily go away.
Unfortunately, if you’ve already made a late payment, there’s really not much you can do. You might be surprised as I was to learn that such infractions will remain on your credit report for seven years. As mentioned this will also result in a big hit to your credit scores but thankfully their sting will wear off over time.
The best thing to do is simply atone for your mistake by making on-time payments in the future. It may take a while but your credit score should rebound even before that seven-year mark. Additionally, once you are back to having decent credit, you might consider asking for a credit limit increase or applying for another source of credit in order to further help raise your score more.
Lack of credit mix
Why it’s a problem:
Credit mix refers to the different types of credit accounts you have, including revolving credit like credit cards and installment credit, such as car loans or mortgages. While credit mix accounts for less of your FICO scores than payment history or credit utilization, it is still a 10% factor. Because of this it’s important to diversify your credit instead of sticking with just credit cards or just loans.
This one’s a little tricky and will depend greatly on your situation. First, although obtaining a loan or financing a car will help with your credit mix (assuming you’re only using credit cards), it could also cost you more money. For that reason you should carefully consider which is the better deal.
As mentioned earlier getting a personal loan to consolidate your debt can be a good deal. However applying for a loan you don’t need just in an attempt to boost your credit score is often foolish. For one, the inquiry required in order to be approved for a loan will require a hard pull, resulting in a small ding to your scores. More importantly, after interest rates and origination fees, you might end up wasting money unless you’re using the cash to pay down more expensive credit cards or higher interest loans.
On the other side of the ledger only having installment credit and no revolving is also an issue. That being said you will want to wade slowly into the world of credit cards. First be aware that opening multiple lines of credit in a short period of time could send up red flags to creditors and hurt your credit scores. For that reason you should find one solid credit card to start with and pay off the balance each month in order to establish good credit history. If you keep your utilization under 10% as well that will do even more to help lift your scores.
Having less than stellar credit can be frustrating but it doesn’t have to last forever — and I’m living, breathing, Millennial proof. As long as you can figure out what the problem is you can likely find a way to make it better. While none of these solutions will be easy or quick fixes, they will at least put you on your way to increasing your credit scores and ultimately saving money.