Okay, your credit is trashed. Maybe it wasn’t even your fault. You may have lost your job and your unemployment benefits ran out. Maybe the only job you’ve been able to find pays only half of what you used to earn. Maybe you had a serious automobile accident or illness. Or maybe – just maybe – it was your fault. You might have just let your spending get out of control and now have a credit score lower than room temperature. Don’t feel as if you’re alone. Thousands of Americans were forced to file for bankruptcy just last year alone. The price of almost everything is going up and there are a number of people – and you may be one – who feels as if the limits on their credit cards are their money. But, of course, it’s not. Its borrowed money that you have to pay back and with interest.
The importance of your credit score
You may not understand or maybe you underestimate the importance of your credit score. It’s critical because a poor score will raise your cost of credit or could even keep you from getting a loan. So what is your credit score? It’s a three-digit number that is generated by analyzing your credit reports and debt profile. When you apply for credit with any type of company, the first thing it will do is check your credit score. The lender will decide from this whether or not you qualify for a loan and if so what your interest rate will be. There is an inverse ratio at work here. The lower your score, the higher your interest rate will be. For that matter, many landlords now routinely use credit scores to decide whether or not to rent to a prospective tenant. And automobile and home insurance companies now use your credit score in calculating your premium.
What difference does a few points make?
Actually, a few points in your credit score can make a very large difference. If you have a good credit score, you should be able to get the lowest rate available, say, 6 1/2% for a 30-year fixed rate mortgage. If you were to borrow $300,000, that would yield a monthly payment of $1857. In contrast, if you have a low score your interest rate might be closer to 7.90% and you would have a monthly payment of $2178. That’s $115,560 more over the life of that mortgage.
Step #1: Check your credit report for errors. You have three credit reports and you should get and review all of them. You can get them one at a time from the three credit reporting bureaus (Experian, Equifax and TransUnion or all together on the site www.annualcreditreport.com. Whichever you choose, be sure to review your reports carefully for errors. If you find one, contact the appropriate credit bureau immediately. If something shows up such as a collection account, a judgment or a lien that is not yours, be sure to dispute it and have it removed from your credit report.
Step #2: Don’t borrow money unless you really need it. There are stores that will give you an immediate 10% discount on a purchase if you sign up for their cards. Don’t fall for this. This could negatively affect your debt-to-credit ratio, which lenders don’t like to see because it appears that you have too much credit available even if you’re not using it.
Step #3: Contact your creditors. If you’re having a tough time making your payments, call your credit card companies right away. Insist that you speak to someone who has some authority and not just the person who first answers the phone. If you can reach a manager, you might be able to negotiate a lower monthly payment plan, freeze the amount of interest you’re paying or have some of your debts forgiven altogether.
Step #4: Pay off your balances. Here comes the tough part, which is to pay off what you owe without incurring any new debt. If you do have multiple credit cards, which is probably the case, pay as much as you can on the one that has the highest interest rate. Once you pay it off, you can start whittling away at the one that has the next highest rate, etc. If you can bring your credit card balances to zero, this will instantly make you more credit worthy. However, don’t close any cards that you are able to bring to a zero balance as this can also harm your debt-to-credit ratio.
Step #5: Pay cash. Don’t use any more credit until you get things in order. When you pay for every purchase with cold hard cash, it’s much easier to keep track of how much you’re spending. Plus, paying cash for your purchases is more “real” than using a credit card. If self-control is an issue, you might put all of your credit cards into a container of water and then freeze it. That way, if you’re tempted to use one of the cards, you will have to wait until it thaws out and by that time the impulse to make that purchase may have disappeared.
Step #5: Make a budget. If you’re having a problem with credit, one of the best things you can do is create a budget. If you know where your money’s going, it’s much easier to cut back on your spending and then use the surplus money to pay off your debts.
Here’s also a video you might find helpful as it boils down credit restoration to just three steps.