Understanding the credit score factors in bad credit and fixing your credit score before a loan can get you a better rate and save money
We’ve all been there, either bad credit or no credit at all. There is a saying in the banking world that loans are for people that don’t need them. That’s because the people with money and perfect credit are the only ones that banks want as customers.
What is there for the rest of us, those that need an emergency loan or credit to buy that dream house?
Fixing your bad credit is actually pretty simple, as it turns out. You may not be able to do it overnight but there are ways to improve your credit score and get better rates on the money you need.
In fact, I boosted my credit score by 140 points in four years after destroying my credit. It only takes a few missed payments to fall into bad credit. It makes protecting your credit score and understanding what affects your score all the more important.
That’s why I put together a complete list of factors that affect your credit score. You’ll better understand credit score factors and bad credit…as well as how to fix it fast!
First step, check your credit report for errors
Your first stop should be checking out your credit report from www.annualcreditreport.com, the only site that offers your free report every 12 months. Your free report is only available once a year, so I use TransUnion to get my FICO score when my free report isn’t available.
If you’re only checking your credit once a year, you leave yourself exposed to identity theft and the bad credit that follows. You only have a limited amount of time to report identity theft so it’s important to be on top of it when it happens. The TransUnion credit monitoring service is one of the least expensive and you can check your report for just $1 on the trial program.
Your credit report will list all the loans you currently hold and your payment history back seven to 10 years. Your payment history is the most important part of the credit score factors, and probably a big reason for your bad credit, so make sure you look closely.
Check the whole report to make sure there are no errors. It happens more often than you would think, missed payments end up on the wrong person’s credit report and destroys their credit score. If you find any mistakes on the report, contact the credit bureau that put it on there immediately.
P.O. Box 7404256
Atlanta, GA 30374-0256
P.O. Box 9701
Allen, TX 75013
P.O. Box 2000
Chester, PA 19022-2000
(These addresses are current as of 2016 but you might want to check them again before mailing your bad credit dispute.)
Besides checking your credit report for items that shouldn’t be on there or for others that might have been recorded incorrectly, be on the lookout for identity theft and any signs that someone else is using your credit. Identity theft happens every two seconds in the United States so a little prevention is absolutely necessary.
It may take a month or two to get the mistake fixed but the time will be well worth it when paying your new loan.
For example, if you have a clean credit history with no missed payments (or maybe even a couple but many years ago) you might be able to get a rating of A on Lending Club and a rate of 8.75% on a loan. If, on the other hand you have a couple of mistakes on your credit report, you would probably be looking at a rating of a B and a rate of 13% at best.
On a $10,000 loan over 60 months with an A rating, you would end up paying $2,382 in interest and your payments would be about $206 a month. That same loan on a B rating and 13% rate would cost you $3,652 in interest and payments of $227 per month. You save $1,270 just by spending a couple of hours to clean up your credit report. That’s an hourly wage anyone would take.
Other Credit Score Factors for Bad Credit
If your credit report is free of errors, there are still a few things you can do to improve your bad credit score. Take a look at the pie chart below, it shows the five credit score factors that affect your credit score and how important they are to the score.
Payment History as a Credit Score Factor
We have already talked about cleaning up your payment history by correcting any mistakes on the report, that’s the most important item of your credit score factors.
If you don’t have much of a credit history or you have a few missed payments on your report, you really need to work on building up a good payment history. This can take the longest to fix your credit score but is the best long-term solution.
Credit cards are like a four-letter word for some people but they are your best weapon in building a good payment history and fixing a bad credit score. Only charge on the cards as much as you’ve got cash to cover and pay the card off at the end of the month. You won’t have to pay interest and will start to see your credit score increase.
As a bonus, there are a lot of credit cards that will pay you cash back or reward points on purchases. Check out some of these cards from USAA for different rewards offers.
Amount of Debt and Bad Credit
The total amount you owe on loans is the next most important part of your credit score. If you can pay off some of your loans, even for a short time, it will help increase your score. I covered a few different strategies for paying off debt in another post including the debt snowball and debt avalanche techniques.
I like to focus on high interest credit card accounts first. Those revolving credit types are some of the types of credit that hit your score the hardest and you’ll save money in interest by paying them off quickly. If you need to, take some money out of savings to pay off these loans but make sure you put the money back into savings after you’ve got your peer loan.
One of the newest ways to fix bad credit is popping up through peer lending and p2p loans. Going online to p2p networks like Lending Club gets you away from the rigid rules of traditional banking and connects you directly with investors.
Because peer loans have fixed interest rates and a fixed monthly payment, they go on your credit report as non-revolving loans. It looks better than a lot of revolving credit card debt and can actually help boost your score.
But even on peer lending sites, your credit score factors still plays an important role in bad credit and getting a loan so it is important that you boost that score as much as possible before applying for a loan.
Beat Bad Credit without Doing Anything
One trick you can do to increase your credit score without having to find money to pay off debt is to ask for an increase on your credit limit. It’s weird that you can actually boost your credit by getting more credit but it does work.
The idea is that the credit bureau looks at something called your credit utilization. That’s how much you owe versus how much credit you have available. If you owe $5,000 on a $5,000 credit limit then you’re maxed out and the situation looks pretty bad.
If the credit company raises your limit to $10,000 then you still have $5,000 in leeway. Nothing changed but it looks like you are in a better place because you’re not maxed out on credit. It’s very important to understand that this doesn’t mean you should rush out to spend more money on your higher limit. It can be a trick to fix bad credit but it can also lead you down a bigger debt hole if you’re not careful.
Fixing Bad Credit the Slow and Steady Approach
You really can’t do much about the length of your credit history. It’s just how long you have been getting loans and have had a financial profile. While opening up a couple of credit accounts can help start building a credit score, don’t rush out to fill out a bunch of credit applications. Applying for several loans at the same time can hurt your credit score because it looks like you’re scrambling for credit.
If you have no loans or credit in your report, you may try opening one credit card account. It’s not a license to spend, so don’t rush out to do some shopping. Use the credit card for things you would normally buy anyway.
Again, don’t forget to pay the entire credit card balance every month. This will avoid having to pay interest and late fees but it will help you build up a history of payments and improve your score.
Check out three more credit score hacks to fix bad credit before getting a loan.
It can take a few months or two to really start seeing your credit score increase after you have taken some of these steps. If you don’t need the peer loan immediately, you can save yourself a lot of money by waiting at least three months.
If you need the money quickly, then at least check out your credit score so you know what is contributing to bad credit. If nothing else, it will give you the opportunity to explain your score on the peer loan application.
Everyone has had a hiccup in their credit history at one point; explain on your peer loan application why you missed the payments or why your score is lower than it should be. Peer lenders will appreciate this honesty and your loan will get funded faster.
- Check your credit report for any errors and notify the credit agency
- Know the credit score factors that affect your score the most
- Pay down any credit card bills or high interest loans
- Use credit responsibly to help increase your score over time
Want more ways to fix your credit score? Check out these 21 steps to fix your credit in six months! I put the entire credit repair process in this one including a chart you can use to beat bad credit. Again, none of the bad credit fixes will happen overnight but they can start increasing your score in as little as a month or two. Use the process a few months before applying for a loan and you could save thousands in interest payments.