Over the past few years, the state of the economy has taken a toll on the credit score of many consumers. Since consumer spending accounts for approximately two-thirds of domestic economic activity, it is critical to the ongoing economic recovery for the U.S. consumer base to have continued access to credit.
Whether applying for a mortgage, car loan, or credit card, most lenders utilize the FICO score to determine the creditworthiness of the applicant. The FICO score was developed by Fair Isaac Corporation, and became the primary tool to qualify loan applicants in the mid 1990s. Since that time, other credit score models have been created, but FICO remains the key model.
Five weighted components constitute the FICO score:
Payment History: 35% Late payments on bills, such as, a mortgage, credit card or car loan, can reduce a FICO score.
Recent Search for Credit: 10% Numerous credit inquiries over a short period of time can negatively impact a FICO score. Usually, this occurs if credit cards at various retailers are requested frequently.
Types of Credit Used: 10% Utilizing only one type of credit (mortgage vs. revolving credit) can decrease a FICO score. Credit cards and home equity lines of credit are considered revolving credit and are weighted more than fixed loans, such as, mortgages or auto loans.
Length of Credit History: 15% A brief credit history can reduce a FICO score. Only the passing of time can help in this area.
Credit Utilization: 30% The ratio of outstanding revolving debt to the total available revolving credit is a heavily weighted factor in your credit score. Typically, a ratio of less than 10% will not hurt a FICO score.
Generally, a FICO score of at least 740 will qualify an applicant for the most favorable credit terms on a mortgage. On the other hand, an applicant will struggle to obtain financing with a FICO score less than 620. However, there are ways for consumers to improve their credit scores.
First, evaluate your credit situation and your ability to make the required minimum monthly payments. To do this, list all debts by interest rate, minimum monthly payment, and outstanding balance. Additionally, segregate them into secured (i.e., mortgage) and unsecured (i.e., credit card) pools. Then total your after-tax monthly income from all sources to see if it is enough to cover your payments. If you have more than enough income, allocate the excess income to your highest interest rate debts. Typically, these will be credit cards. However, if you do not have enough after-tax income to honor all payments, contact the creditors to see if they can amend your terms. Continue managing this process until your debt situation improves.
Second, order your credit report from AnnualCreditReport.com. There is no charge to do this on an annual basis. If you find any mistakes, such as, records of past due payments that you can show you made on time, or accounts listed that have been closed, contact the reporting agency and ask to have the information corrected. The credit reporting bureau must be able to verify the accuracy of anything reported in your file. Often times, due to financial institutions changing names as a result of mergers, it can be difficult to verify some reported information.
Third, if you are looking for a job and are concerned that a prospective employer might pull a copy of your credit report, go to the three major credit bureau websites to add your own commentary on why your credit situation is in its current state. This is similar to adding a cover sheet to a resume. It offers color on your situation that could help alleviate some concerns the employer might have.
Fourth, talk to a credit union about your situation. Some credit unions can have more accommodating terms for new credit offerings to help rebuild your credit history. But be wary of any offers from companies claiming to solve your credit problem. A marked improvement typically takes time. These companies target immediate results by essentially disputing everything in your credit file, and thus, temporarily disqualifying negative marks while the credit bureaus validate your information.
Free Online Tools
If you are struggling with debt, ReadyForZero.com is a free website that can help you develop a plan and make suggestions to reduce your debt to zero. The ReadyforZero website securely links to your checking, savings and credit card accounts. It then analyzes your debt and provides an overview of when you’ll be out of debt if you only make the minimum payments.
ReadyForZero features a way to find a compromise that works for you. It has one slider that changes the amount you pay each month, and the other slider adjusts the amount of time it will take, allowing you to find that perfect balance between time and money. It also tracks your progress and sends you reminders, which can keep you moving and help motivate you if you veer off track.
The website will not move your money or negotiate with your creditors, so the responsibility for managing your money remains with you.