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How to Build Your Credit Score

by Influential Times   ·  April 21, 2021   ·  

How to Build Your Credit Score

by Influential Times   ·  April 21, 2021   ·  

Like it or not, building and having good credit matters.

A good credit report is reflected in just three numbers. These three numbers show lenders whether you are a good or bad credit risk. 

It may be unsettling that your entire bill paying and borrowing life can be reduced to three numbers, but this is the system that helps dictate how much you can borrow, how much you pay in interest, even your odds of being hired or promoted.  

How Credit Rating Companies Work

What credit reporting agencies prepare their reports, they are gathering information on a person’s financial life, including their bill paying, borrowing, debt histories, and loan defaults. What goes into these reports is a person’s record of making timely bill payments, the amount of credit they use, and their overall record in managing debt.  

Using public records, the companies also look for bankruptcies, foreclosures, tax liens, and other court-related judgments that have been filed against you. This information is then compiled into an algorithm that produces a report. This information is then sold to companies that want to extend credit to you or want other types of background information about you.

Today, there are three major publicly traded corporations focused on rating the credit histories of individuals. These are Equifax (founded in 1899), Experian (founded in 1826), and TransUnion (founded in 1968).  The reason why these companies were created is simple: businesses have always been concerned about customers who do not pay their bills.  While each credit history company uses its own methodologies to produce a credit report, they all rely on data from major consumer lenders that issue credit cards, mortgages, and make other loans. 

While these are the best-known companies in the credit reporting industry, there also are about 50 other companies that are classified as businesses engaged in compiling consumer credit reports.

These are specialized firms that track people who have bounced checks (ChexSystems), check screening companies (Certegy), verify identities, detect and prevent fraud (Innovis), evaluate non-prime consumers (Clarity Services), as well as specialists in sub-prime lending that don’t report to the three major agencies (CoreLogic Teletrack), and aggregate credit and personal information (Credco). 

These companies are regulated by the Federal Trade Commission, guided by legislation contained in the Fair Credit Reporting Act passed in 1970.  This Act allows any consumer to request their credit file once annually and to challenge any incorrect information these files contain.

The Act also has rules about when a company can access credit history data.  The most common access to a credit report, called “permissible purpose,” is allowed when a business wants to issue credit, collect a debt, determine whether you should be employed, or underwrite insurance coverage.

Perhaps the best-known company in the credit rating agency world is The Fair Isaac Corporation (FICO). Consumers may recognize the FICO name since it is the most common credit score summary used by businesses.  While FICO created and manages its scoring and reporting system, it does not collect any credit report data.  Instead, its reports are based on data collected by the three major credit gathering companies.

Why Credit Scores Matter

An abstract illustration with a man counting on a big calculator. Coins playing on a swing and slide.

Credit scores determine your creditworthiness. In a consumer society based on credit card purchases and making large loans, businesses want to feel confident they are lending money to people who can repay their debts. 

Studies have found that people with bad credit have a higher accident risk, so they often pay more for car insurance. Bad credit is even used to determine if you can rent an apartment.

This is why it is important to build your credit score if it is low.

FICO scores range from 300 to 850. A minimum FICO score of 740 typically is considered good and this should allow you to get a very favorable interest rate. A person with poor credit has a score below 670. A score between 580 and 669 is considered fair, and one between 300 and 579 is poor.

What Comprises a Credit Score?

To determine a final credit score, a person’s financial history is broken down into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%). 

According to Experian, the most important factors that generate your credit score are:

  • Payment history.  If you pay your bills on time, this raises your credit score. Missing a loan payment raises a red flag among the rating agencies and that’s why this factor accounts for 35% of your score.
  • Length of that history. This factor looks at the average length of time you have had available credit with an issuer. The rating companies like people who have a long credit history than those who are just beginning to build their credit. This accounts for 15% of your score. 
  • Amounts owed. This is based on your credit utilization ratio, or the percentage of credit you use from your credit limit. This ratio is applied to each of your credit cards.  This number accounts for 30% of your total credit score. 
  • The mix of debt you owe. This includes car loans, credit cards, student loans, mortgages, or other credit products and accounts for 10% of your score.
  • New credit account applications.  If you are applying for new credit cards or too many people are inquiring about your credit, it can raise a red flag to the agencies.  This accounts for 10% of your score.

Building Up Your Score vs. Repairing Your Credit

If you have a low credit score and want to raise it, be prepared to wait. This is not a fast process. Credit card companies report to the credit agencies regularly, at least monthly, but the credit card companies may not be reporting to all the rating agencies simultaneously, nor do they report to all three at one time. As a result, your credit history is changing for better or worse all the time.

While credit agencies gather all types of financial information, some events are more detrimental than others. If you have been targeted by a collection agency or have filed for bankruptcy, your score will suffer. These bad experiences, including court judgments made against you and tax liens, will remain on your credit report for seven years. Of these bad experiences, filing for bankruptcy is the worst. This event can lower your score by 200 points.

However, people who have gone bankrupt can rebuild their credit scores above 700 after about four years by diligent credit management.  This includes paying bills on time, using only 30% or less of your credit limit, and keeping all debt payments current.

The ways to improve your credit score are simple: pay bills on time and don’t get close to hitting your loan limit. The rule is to stay below 30% of that limit. This shows the card company you are restrained and can control your spending.

If you want to build credit, one way is to open a secured line of credit from a credit union. You can then receive a credit card accompanied by a line of credit. This line of credit can then be used to pay off a credit card. 

Another tactic is to ask a family member to add you as an authorized credit card user.  This relies on the primary card holder’s positive credit card history and it then becomes part of the new borrower’s history (provided both pay debts on time.)

Younger people who become authorized users at a lower age build up their credit card history sooner. This is then reflected in a higher credit card score. Note that becoming an authorized user is different from being a co-signer to an account. Co-signing is dangerous since the primary user is liable for all charges made by the other person on the account.

Another tactic to improve credit is to make more than one credit card payment per month.  This reduces debt balances and shows your credit card company that you have responsible payment habits. For younger borrowers, it helps your credit score if you avoid making large credit card purchases.

Card companies also like to see a habit of purchases, so if your purchases have a low average cost and the card company then sees a major acquisition, it sends a bad message to the card issuer.

Borrowers should also beware of accepting credit card offers with tantalizing low interest rates. These teaser rates are temporary. After the introductory period expires, reality will hit.  People who see these low rates and move balances, soon discover the new rates will be the same as those offered by your original card company. 

Factors That Damage Your Score

The factors that damage your score are missing payment deadlines by over 30 days, charging your card to its maximum limit, and staying above the 30% maximum utilization of your credit card limit.

Building your credit score is your responsibility. That’s why you should review your credit reports from each agency to look for mistakes. Borrowers have free weekly access to their reports from all three bureaus through April 2022.  

This change is due to the COVID virus, which caused credit card companies to make adjustments to their payment schedules. If you received any payment allowances from your card company, they should be reflected in your card payment history. 

You can request copies of your report by contacting AnnualCreditReport.com to check for any mistakes. Note that many agencies must supply a free report, however, they can charge for your credit score.

How to Correct a Mistake in Your Credit Report

Two people watching at man who rides a bicycle onto a pyramid of gold bars.
Building your credit score is your responsibility.

Mistakes on your credit payment history impact your score.

After you receive your credit histories from the three major agencies (Equifax, Experian, and TransUnion), look for inaccurate information, such as:

  • Whether the report includes accounts from other people or charges that you did not make or authorize;
  • Incorrect information.  This includes the names of past employers, your Social Security number, charges that do not look familiar, and incorrect mailing addresses. This is all information that identity thieves use to defraud people.
  • Information that is too old to be included in the credit report. If one of the following bad events is over seven-years-old, it should be excluded from your report. This includes payments that are missed, repossessions, collections, student loan delinquency, foreclosure, and bankruptcy. Note that Chapter 7 bankruptcies remain on your record for 10 years. 

If you discover a mistake, the Federal Fair Credit Reporting Act (FCRA) specifies that you have a right to file a complaint with the appropriate reporting agency in writing. 

To dispute a mistake, the Federal Trade Commission recommends that you send a certified letter (with a “return receipt requested”) to the credit agency that specifically states what you are disputing. Their site includes a sample letter that you can send to the rating agency. 

You should then contact the company or person who made the inaccurate claim against you.  The company has 30 days to respond.  

The agency then contacts the company that made the report to determine whether it happened. After their investigation is complete, the credit reporting company will contact you in writing and must provide a free copy of your report if the dispute results in a change. If a mistake occurred, the agency must also contact the other two agencies to notify them of the error. 

The best way to correct an event with a debt collection agency is to negotiate a repayment plan and then ask that upon repayment, the collection agency must erase the incident from the credit report.  If they only remove the debt amount, it will still impact score.  The best solution is to have the collection event erased entirely.

Building Your Credit Score and Maintaining Good Credit 

In an advanced consumer society that relies on large and small purchases, having a good credit score determines your lifestyle. 

However, managing your purchasing and credit payment history is your responsibility. Managing debt, payments and credit require discipline should become a lifelong habit.  But becoming a good borrower will make a positive difference in your life.

–Chuck Epstein

2 Comments

  1. […] Credit scores are important for big purchases and leases such as cars, personal loans, and mortgages. High or low your credit score determines how much interest you will pay over the life of the loan. […]

  2. […] how do you build a good credit score and keep […]

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