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About your credit score and things you can do to improve it

Sunday, November 9th, 2008

Your credit score, and how it affects you
Consumers credit scores are designed to measure the risk of default by taking into account various factors in a person’s financial history. To get the best rates on loans and credit cards you need a good credit score. Scores range from 300 to 850 – the higher, the better. Scores below 400, or above 800 are rare.

A high score means lenders generally consider that you manage credit responsibly and aren’t likely to default on your payments. For that, you will be rewarded handsomely. A low score will more likely result in denial of credit or higher rates. Late payments, maxed-out cards and an excessive number of credit lines could leave your score sorely lacking. Never mind foreclosures or bankruptcies.

The average credit score nationwide is around 660. Generally, if your score is in the mid-700s or higher, you’ll be offered the best rates. If your score is less than 620, you’ll pay dearly for credit. The difference between best and worst mortgage rates can be more than 3%!

The good news is that it is always possible to improve your score. Improving an already good score takes 60-90 days, and perfecting it takes up to 6 months. Poor credit scores take 12-24 months, over even longer to improve and perfect. It’s generally a long haul – like improving your cholesterol or losing weight.

How is your credit score calculated?
The exact formulae for calculating credit scores are closely guarded secrets. The following components are the approximate weighted contributions:

  • 35% – Punctuality of payment in the past (only includes payments later than 30 days past due)
  • 30% – The amount revolving debt (credit card balances, etc.) as a percentage of total available revolving credit (credit limits)
  • 15% – Length of credit history
  • 10% – Types of credit used (installment, revolving, consumer finance)
  • 10% – Recent search for credit and/or amount of credit obtained recently
  • 8 ways to boost your credit score

    1. Check your credit report for accuracy.
    You can get a free credit report at FreeCreditReport.com. You are entitled to one free copy per year. Errors are maddeningly common: Over 25% of reports contain errors that are serious enough to result in the denial of credit, according to a July 2004 report by the U.S. Public Interest Research Group. Be sure to report any inaccuracies to all three credit-reporting agencies: TransUnion, Equifax, and Experian. Here is a letter you can use.

    2. Pay your bills on time
    Missed payments are the single biggest killer of credit scores. Your past behavior – late or missed payments, foreclosures, bankruptcies etc. count for approximately one-third of your credit score.

    3. Pay down balances
    One-third of your credit score is based on the amount you currently owe in relation to your credit limit. Try to keep your balances at 50% or less of your credit limit.

    4. Keep old lines of credit open
    15% of your score comes from how long you’ve been managing credit. Closing old accounts shortens your credit history and lowers your score. Lenders also take into account the average age of your accounts, so an older account can help balance newer credit.

    5. Limit new credit
    Take on new credit only when you need it. New credit can hurt your score twice. For starters, new inquiries for credit count for 10% of your score – and a flurry of new credit requests can lower your score. Also, once a new credit line is secured, the average age of your accounts will shorten, which in turn can drag down your score even more.

    6. Communicate with your creditors if you have difficulties
    Many creditors are willing to be understanding of difficult financial situations and short-term financial problems, especially if you openly communicate with them in a timely manner. Forcing a creditor to turn your debt over to a collection agency will simply cause you bigger problems because collection agencies are relentless when it comes to recovering money. And the negative information that’s placed on your credit report will have a long-term negative impact on your credit score. Your creditors may be willing to do one or more of the following things to assist you:

  • Reduce the interest rate
  • Reduce the monthly minimum payment
  • Waive extra finance charges and late fees
  • Allow you to skip one or more payments (and extend the length of the loan)
  • Close the account and allow you to make affordable payments to slowly reduce the outstanding balance over time.
  • Close the account and accept a settlement for less than the amount you owe
  • Allow you to refinance the loan at a lower interest rate and/or for a longer term to reduce your monthly payments.

    7. Goodwill adjustments
    A single late, or overlooked payment can affect your credit score for years. A goodwill adjustment is a gesture from a creditor to re-age an account and report certain late payments as having been made on time. It is entirely up to the creditor – so you need to ask nicely :)) Here is a sample letter you can use. 
    8. You’ve got a second job…
    Yes, you do. It pays well, no taxes, and you don’t even have to apply for it. It is also slave labor because if you don’t work at it you can get punished. I am talking about managing your credit score.

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