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Improving Your Credit Score
Credit scores are designed to measure default risk by taking into account various factors in a person’s financial history. Credit scoring is often used to determine pricing for auto and homeowners insurance. Lenders such as banks and credit card companies use credit scores to assess the potential risk posed by lending money to consumers and to minimize losses caused by bad credit. Using credit scores, lenders determine who qualifies for a loan, at what interest rate, and what credit limits. In the United States, a credit score is a number that is based on a statistical analysis of a person’s credit report, and is used to represent that person’s creditworthiness—the likelihood that that person will be able to repay their debts.
In the case of insurance companies, the likelihood that a person will pay off their debt is directly related to the likelihood of filing a claim against their insurance policy. People with low credit scores have a history of filing claims according to an overwhelming amount of research and statistics over the past 15 years or so. The theory is that when times are tough small relevant claims are now being submitted to the insurance company, the claims are also padded to look bigger so people can get a little extra cash from their company.
A credit score is based primarily on credit report information, usually from the three major credit bureaus. Although Fair Isaac Corporation develops these credit score versions for various agencies (known as FICO scores), they are different numbers, and are updated periodically to reflect current consumer loan repayment rates. Recently, some of the agencies that generate credit scores are also producing more specialized insurance scores, which insurance companies use to evaluate the quality of potential customers, as I mentioned earlier.
Understanding your credit score is the first step to improving it and working for you instead of against you. With an improved credit score, lower expenses, proper asset and identity protection, and some extra income on the side, you can eliminate your debt completely in a few years (no kidding) and live a less stressful life. Here are some tips to improve your credit score relatively quickly:
Payment history – Your monthly bills include expenses and debt. Debts are debts such as credit cards, car payments, mortgages, etc. You should ensure that your loan is paid on time every month. Any history of late payments (including missed payments and delinquent payment statuses) is a negative factor. No reported payment history on any account is also a negative because lenders can’t tell if you’ve made payments on time or late. Some cases of late payment are worse than others. If you haven’t been late on any payments recently, lenders may think you’re responsible and won’t miss (or stop making) payments. Lenders realize that many people sometimes pay late. Therefore, being late on a single payment is usually not as detrimental as being late on two or more consecutive payments. Likewise, being late on multiple accounts is usually worse than being late on one. Also, if you have collection accounts or negative public records such as bankruptcy or court judgments, lenders may view late payments as a more serious problem. These types of credit records indicate a pattern of credit problems.
Loans and Loan Limit Ratios – Having accounts with a high credit limit or loan amount is a positive factor, as it indicates to the lender that other lenders have trusted you with a lot of credit in the past. On the other hand, accounts with low credit limits or loan amounts are a negative factor. This may suggest that your credit reports contain information that was of concern to lenders when determining your credit limit or loan amount. Finally, having no accounts with a reported credit limit or loan amount is a negative factor because lenders cannot assess how much other lenders trust you with credit. It may be beneficial to close lower limit accounts and ask for higher limits on your preferred accounts.
activity – Accounts listed on your credit reports are a positive factor because the payment history of these accounts shows lenders how well you’ve been paying your bills. Therefore, too few accounts or too few open accounts can be considered negative. However, having too many accounts or adding new accounts too quickly can also be viewed as a negative because lenders worry that you’re spending (or preparing to spend) beyond your means, even if you’re not late on any payments. Note that closing accounts does not change this. Also, if you don’t currently have credit, getting your first few credit cards can be difficult and involve high fees, high interest rates, and low credit limits. Note that accounts from personal finance companies (which specialize in lending to people with credit problems) may be considered negative.
Revolving Credit Balance – High balances are a negative factor because lenders worry that you are living beyond your means and will not be able to repay them. This is especially true for credit cards. For installment loans such as mortgages and auto loans, lenders often use the ratio of loans that are still unpaid to judge your ability to take out new loans. If too little of your installment loan balance is paid off, lenders may not give you more credit that could add to your debt. Typically, lenders evaluate how much you owe (your debt) in relation to how much you earn (your income). However, no matter how high your income, having too much debt can lower your credit score because lenders know that adverse changes in your employment and life events like divorce or illness can make it difficult to pay your bills. A low balance, on the other hand, is a positive factor because borrowers don’t stand to lose much if you are unable to pay them back. However, not using your credit accounts can be considered a negative factor, as it does not provide lenders with information about how you typically use credit and repay your debts.
Apply for credit – Applying for credit too many times in a short period of time can lower your credit score. When you apply for any type of credit (such as an auto loan, credit card, department store card, or mortgage), the lender considering your credit application checks your credit history. This is recorded as a “hard inquiry” on your credit report. Although inquiries are an inevitable consequence of applying for credit, lenders like to see more inquiries within a short period (eg 6 months). That’s because they can’t tell if you’re “shopping around” for the best deal or if you’re struggling to get credit because of financial problems. Therefore, try to limit your comparisons to a small number of lenders when “shopping” for the best offer.
In summary, it is very easy to improve your credit score by 30-50 points in just three months. It could be the difference between paying 25% more or less on your car insurance, or getting a credit card or mortgage with a 3-5% higher or lower rate. These small differences will definitely affect your ability to progress in the game. People who pay too much for insurance and have high interest rates on loans will never be debt free or get out of it all.
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