Today, we feature a guest writer Lori Wade, content writer for Alternate Finance, who is interested in a wide range of spheres from business to entrepreneurship and new technologies. If you are interested in the technology or banking industry, you can find her on Twitter or LinkedIn. Thank you for sharing your knowledge with us Lori!
While credit scores are essential for mortgages, personal loans, and other types of lending, what does your credit score show? Of course, we all know about credit scores; high credit scores are better than lower scores, but how do lenders use this information, and how can you improve your ranking.
Before we look at ways to improve your credit score, it is worth reminding ourselves exactly what your credit score means and how it is used.
What does your credit score show?
When you apply for credit, missed payments or other financial difficulties will be reported to a central database by your lenders. It is essential to clarify that missing just a couple of payments would not result in a report to the central database. However, if you have a prolonged period of missed payments, this would go on your credit report.
Many people automatically assume that your credit report calculates your credit score. While the two are connected, your credit score does not appear on your credit report. There are several credit rating agencies, with the three most popular seen as:-
When checking your credit score across different credit rating agencies, you will find they are slightly different. Each of the above credit rating agencies would receive the same information when requesting your credit report. However, how they interpret and use that information to arrive at your credit rating will be slightly different. The general outcome would be the same, but the individual credit rating scores won’t.
It is also important to remember that credit rating scores do not dictate whether or not you are offered finance. The lenders that request your credit rating score will make the final decision whether to provide you with credit based upon their criteria. A credit rating score reflects your money management skills; it really is as simple as that.
10 ways to improve your credit rating score
Even though credit reports and credit scores are an integral part of our everyday life, there are many misunderstandings about ways to improve your standing. We will now look at some practical ways to enhance your reputation amongst lenders and improve your chances of securing finance.
Monitor your credit reports
The Internet has brought credit rating agencies in from the shadows, with many online companies now offering free credit checks and credit reports. Typically you will need to pay extra for more detail, but many of these free services will give you an idea of how your rating is changing. In addition, you can request a copy of your credit report via the three leading credit rating agencies, although this will likely come at a relatively small cost. So how does this help you improve your credit score?
Unfortunately, no system is foolproof or human-proof. Consequently, you may see errors on your credit report or attempts at identification theft/fraud from time to time. Therefore it is crucial to monitor your credit report and credit scores regularly. Even if your credit report is accurate and up-to-date, it will give you an idea of how the system works and when missed payments and financial difficulties are noted.
Challenge errors on your credit report
If you find any anomalies or discrepancies on your credit report, you must challenge these as soon as possible. For example, there may have been a misunderstanding, someone may be trying to defraud you, or there may be issues with previous borrowings.
Credit reports/score services will include a list of individual companies that have added entries to your credit report. If you believe the information is incorrect, then you should contact the particular lender – only they can correct their errors. Due to the impact that mistakes can have on your credit score and ability to borrow money, your queries are usually addressed relatively promptly. However, even when the errors have been corrected, where possible, you should clarify how the mistake happened and ensure there is no repeat.
Avoid multiple credit card applications
There is a balance between demonstrating your money management skills and having too many credit card accounts. Remember, when approaching a lender, they want to see evidence that you have good money management skills and take a focused approach to this issue. Therefore, the scattergun approach where you apply for multiple credit cards is not the best idea.
It is also worth noting that when you apply for a new credit card, the credit card company will perform what is known as a “hard inquiry”. This type of inquiry will show on your credit report and impact your credit score. If you need to make multiple applications, for example, if you are looking to arrange car finance, this should be done in a batch. When reviewing your credit report, lenders will appreciate you were looking for the best deal at the time, as opposed to constantly applying for new finance.
Reconsider closing that old account
Many people will close down their old credit card account once their balance has been transferred to a more competitive rate with a new credit card company. This seems perfectly sensible?
It may be worthwhile maintaining that the old credit card account and using it sporadically when it comes to your credit score. Experts estimate that 15% of your credit score relates to your credit history. So, if you close your oldest credit card account, you are effectively reducing your credit history on your credit report. If you do use your older credit card sporadically, don’t forget to pay it off!
This is an area of confusion; the misconception that focusing on your more active sources of finance will somehow boost your credit score. If you look at this from a lender’s point of view, the fact that you have any credit card shows that a credit card company believes that you are a credible customer. An older card is just the icing on the cake for your credit report.
Open several credit accounts
Those who refuse to take on credit will likely find that their credit score will remain relatively low. As the credit rating agencies do not have access to your savings, income, or other details about your private life, they would find it difficult to assess your money management skills. As we touched on above, it is essential not to make multiple credit applications regularly. However, you will benefit from having one credit card, one home mortgage, one personal loan, and perhaps one car loan – as long as you can afford the repayments.
Remember, prospective lenders are not assessing your financial wealth; they evaluate your ability to manage your finances. There is a common misconception that credit rating agencies have access to all of your personal details; they don’t.
Maxing out your cards is not a good idea
One thing which is becoming more apparent when looking at credit scores is the term “balance”. The need to find a balance between the number of credit accounts you have, how you use them, and more importantly, how you repay them.
While the figures will vary slightly from company to company, it is believed that 30% of your credit score relates to your amount of debt as a percentage of your maximum credit. For example, if you have a credit card with a $5000 limit and your balance is $4950, this is way too high. However, if you had a limit of $5000 and a balance of $2000, this looks way more manageable. Try to put yourself in the shoes of a potential lender. If you are bouncing off the limit of your credit, what does this suggest?
Request an increase in your credit limit
When you first take out a credit card, you will likely be given a standard limit while your spending habits and money management skills become more apparent. As we touched on above, your credit rating will be impacted by the element of finance that you have utilized. So, if you can afford it and you are approaching the limit of your credit card, you may be able to ask for an increase.
This is a double-edged sword. The fact that a credit card company would consider giving you an increased limit is a positive factor. Then there is the change in credit utilization figure, i.e. you will be using less as a percentage of your maximum credit.
Focus on repaying high-interest debt
It is essential to budget your income, especially when it comes to debt repayments. Many people tend to tackle relatively low-interest finance leaving high-interest debts to rack up significant interest charges. There is a “feel-good factor” when you are have paid down this low-interest debt but is this the most sensible approach?
The best way to manage your finances is to pay the minimum payments across your financial obligations. Then assess how much more you can afford to pay down your high-interest debt. Don’t forget, the less you repay each month on your high-interest debt, the more interest on interest, and the cycle goes on. High-interest debts can quickly build up in the background, and at some point, they can become a problem. The more financial issues, the greater the impact they will have on your credit report and, ultimately, your credit score.
Using joint account finance to your best advantage
The issue of joint accounts and joint finance looks relatively straightforward but is a little more complex than you might think. For example, a joint savings account would benefit both parties to the same degree. However, a joint credit arrangement may allow the “weaker party” to benefit from the “stronger party”. So how does this work?
When applying for joint finance, the lender will consider the credit reports and credit scores of both parties. Collaborative financial arrangements are not always as they seem. Lenders effectively see joint financial arrangements as two separate transactions where both parties are fully liable. Even though you may be a 50-50 party to the contract in your mind, if the other person were to default, you would take on the remaining debt.
Therefore, if you have a lower credit score than the other joint party, you may benefit from their superior money management skills in terms of credit scores. So, it is likely that you would, as a joint party, have access to a greater degree of credit than if you had applied in your name. An interesting quirk which you can use to your advantage!
Talk to your lenders at the first sign of trouble
Unfortunately, many people experiencing short, medium, or long-term financial problems leave it far too late to talk to their lenders. If you predict financial issues on the horizon, which may stop you from covering your financial liabilities each month, you should speak to your lenders. Put yourself in their shoes; they would rather reorganize your finances in the short term so that you can maintain repayments even if at a lower level for an extended period.
Once you start to default on loans, credit cards, and other financial repayments, the damage is done for many people. The longer you leave it, the fewer opportunities open to you to avoid significant issues on your credit report and ultimately a reduced credit score. Many people are concerned that approaching their lenders to discuss financial problems would see all of their loans recalled at the same time. This wouldn’t happen!
If you were experiencing financial difficulties, the chances are you would have limited funds to cover your outstanding debts. But, as they say, you can’t get blood out of a stone. So, the best way is to work with your lenders to address any short, medium, and long-term issues. You will be surprised by how receptive they can be.
You can make numerous tweaks to your credit arrangements that will impact your credit report and, ultimately, your credit score. Many people automatically assume that lenders and credit rating agencies have full access to your personal life, your income, expenditure, etc., they don’t. However, lenders will extract as much additional information as possible from you via their application forms.
There are two main factors to take away from this article. Firstly, managing your finances is an ongoing activity and one that should be respected. Secondly, if there is the merest hint of financial trouble ahead, then you should speak with your lenders and discuss any possible alternative arrangements. The fact that you are addressing any potential financial issues would be seen as a positive; indeed, some might argue, a more proactive approach to money management.