Whether you are establishing credit or trying to restore credit, building credit is a lengthy process and depends on many factors. There are different options to establish or fix credit depending on what your goal is. It is important first to discuss how a credit score is calculated, and which factors have a higher impact on your score.
What Makes Up Your Score?
There are various scoring models, but the most common is from the Fair Isaac Corporation, otherwise known as a FICO Score. Up to five categories of information are used to determine your score. Payment history and the amounts owed make up about 65% of your total score. The length of your credit history makes up about 15%, and new credit and credit mix are 10% each. The exact percentages that make up your score will vary depending on which version of FICO used and the specifics of your file.
How are FICO Scores Used?
Every time you acquire a new line of credit, such as a credit card, mortgage, or loan; the creditor will report that you have opened an account with them to agencies called credit bureaus. Three of the major agencies are Equifax, TransUnion, and Experian. A creditor may report to one of these bureaus or all three. They may report to a different bureau entirely. Ideally, you should find a creditor that reports to all three bureaus. The creditor will then report, often monthly, about the status of balances and payment history. Each bureau uses a calculated FICO score to provide creditors a quick overview of your credit worthiness and history.
Creating Enough Credit History for a FICO Score
A great way to establish new credit is to open a secured credit card, recommended for people looking to acquire new credit because they require a security deposit. The amount of the security deposit is generally equal to the amount of credit given. These cards are not meant to be long-term solutions. Most people use them until approved for a normal unsecured credit card.
Another option is to take out a credit-builder loan. This loan works the same as regular loans, but the loan payout comes after the payments are made rather than before. This allows you to create a stable payment history, and get rewarded that the end. Local credit unions and banks typically offer both secured credit cards and credit-builder loans. Be sure to verify that the bank will report the account to at least one of the major bureaus, ideally all three.
A third option is potentially a low-limit store card. Often, stores will grant cards with low spending limits to consumers with bad or little credit. Used responsibly, these cards can help improve your payment history, thus increasing your credit score.
Reading Your Credit Report
How can you find out what’s in your report? Every year, you are entitled to one copy of each of the bureau’s reports for free.
The reports can be a bit overwhelming at first if you aren’t familiar with them. Each report will be formatted differently, but the information is still the same. You will find your name, address, birthdate, employment, and other identifying information. This information is not used to calculate your score, but merely as an identifier.
Next, you will see information from each lender you work with, also called trade lines. You will see the name of the creditor, the type of account (i.e., credit card, mortgage, auto loan, etc.), the balance, and the amount financed and owed. Trade lines can also include your payment history, but you may see it in its own section as well.
Credit inquiries separate into “hard” and “soft” inquiries. Hard inquiries come from applications to creditors. These types of inquiries stay on your report for a couple of years. They may also initially lower your score, but their impact will fade over time. Soft inquiries are typically third-party inquiries that check your report for pre-approved offers, and companies like Credit Karma which provide consumers with a snapshot of their credit.
The last section of information is for collections, charge-offs, public records, and bankruptcies. This is a section that is ideally empty, but if it isn’t the entries fade over time and are removed 7-10 years. Even if you pay off the accounts, these entries will remain for some time.
Fixing Incorrect Information is Key to Credit Repair
It is important to monitor your reports regularly to keep your information up to date. Incorrect information in your trade lines, inquiries, and delinquencies can have a negative impact on your credit. If you find incorrect information, you can file a dispute with the bureau to have the information removed or corrected. You can also file disputes with the creditor themselves. Creditors must remove information if it is incorrect or unverifiable. It is important to note that they cannot legally remove negative information that is accurate.
If you feel safer hiring a credit repair company to clean up and monitor your credit, there are options for that as well. Your Personal Finance Tips features credit repair reviews so you can find the best credit repair companies around.
It is important to note that these companies can legally do nothing different than you can. Reputable companies will be upfront with you about what services they offer and how much they charge. They will also keep you informed of their progress on your account. Always research the credit repair company you plan to use because there are many scammers eager to charge for services they cannot provide. Customer reviews can be very helpful in this aspect of researching.
Learn more about credit repair and personal finance today with Your Personal Finance Tips.