If you’ve had an overdue student loan, years of high credit card balances or even a foreclosure, you probably have a low credit score, which can cost you a bundle if you ever want new credit.
With poor credit, you may simply not be able to get many credit products like credit cards. But if you have a decent income, you can often still get an auto loan or a mortgage (yes, even today), but there’s a catch: lenders charge a higher interest rate to homebuyers who have poor credit.
What does that mean, exactly? Well, versus a borrower with good credit, someone with poor credit can pay $50,000 more in interest on a mortgage or over $200,000 more over a lifetime of borrowing.
The good news is—as you should know if you’ve read this blog for a while—is that you can repair your credit score legitimately, and you can do it yourself. Don’t fall for ads from lawyers or authors promsing easy credit repair; they’ll just charge you a bundle to take some simple steps you can handle yourself.
1. Know where you stand
Before you begin do-it-yourself credit repair, you’ll want to get copies of your full credit reports from all three bureaus (Experian, TransUnion, and Equifax). You can get your reports truly free, once a year, at www.annualcreditreport.com or by calling 1-877-322-8228. Other websites may claim to offer free reports, but the Federal Trade Commission (FTC) warns that these offers are often deceptive.
Note, however, these reports will not contain your credit score, which you may want to see before applying for a mortgage as your score coorellates with the interest rate you’ll pay. This free credit score service is truly free, whereas other provide your credit scores either as a “free trial” or for a modest fee. Credit scores range from 300 to 850; a score of 740 or above is enough to qualify you for the lowest mortgage rates. If you discover that your score is below 740, there are important steps you can take.
2. Dispute errors
The first step in repairing your credit score is to dispute incorrect information on your credit report. Unfortunately, errors are common. Once you have the copy of your full credit report in hand, check your identity information (Social Security number, spelling of your name and address), and credit history.
Review the list of credit cards, outstanding debts, and major purchases. If you see any mistakes or questionable items, make a copy of the report and highlight the error. Next, gather any information that you have to back you up, such as bank account statements, and make copies of these as well.
Write a letter to the specific credit reporting agency that shows the falsehood, whether it is Experian, Equifax, or TransUnion. Explain the mistake and include a copy of the highlighted report along with your documentation. It’s a good idea to send this letter by certified mail, and keep a copy for yourself. The reporting agency has 30 days from the receipt of your letter to respond. The Federal Trade Commission provides advice on contacting the credit bureaus about discrepancies. Here are the contact numbers and web sites for the three credit bureaus:
- Experian: 1-888-397-3742 – www.experian.com
- TransUnion: 1-800-916-8800 – www.transunion.com
- Equifax: 800-685-1111 – www.equifax.com
3. Stop the bleeding
Once you deal with any errors on your credit report, there are only three simple things to do to repair your credit:
- Pay all of your bills on time
- Pay down debt (especially credit card debt)
- Avoid applying for credit
But before you can do these things, you need to make sure you’re not spending more than you earn. Yes, you need a budget. To start, review your tax returns for the past two years to get a sense for how munch money you actually take home in a year.
Subtract your regular monthly expenses (rent or mortgage, car payments, and home, car and health insurance) from your current income. Next, estimate your monthly spending habits for other expenses such as gas, groceries and entertainment. Create a limit, based on your income, of what you can spend in each of the different categories of expenses. For example, if you tend to spend $400 a month on groceries, try to stick to $300 a month on groceries by making changes like buying generic brands, using coupons and resisting impulse purchases.
If you’re behind on one or more monthly bills or you need help living within your means, you can turn to a credit counseling or debt management agency (learn more about if debt management is right for you), or you may be able to find free counseling at your local library or another non-profit organization.
4. Pay all bills on time going forward
Pay all of your monthly bills on time, period!
If you are behind on any, get caught up as soon as you can. On-time payments are the single most important factor to your credit score, and your credit won’t improve until you can consistently pay every bill on time.
5. Pay down credit card balances
Finally, take charge of your credit cards. If you have any outstanding balances, make room in your budget to pay down these debts bit by bit, every month until they are G-O-N-E.
Know your credit limits and make every effort to stay well under the maximum when charging items. Debt is analyzed by ratios. If you charge $500 on a card which has a $1,500 limit, you’ve used 33%, which is better for your credit score than charging the same amount on a card which has a $1,000 limit (50%), both of which are better than being maxed out (100%). Pay these credit cards down, but don’t cancel them. The total amount of available credit affects your score, even if you owe nothing.
6. Don’t apply for new credit
Finally, resist the temptation to open a new credit card, even when a store offers a discount on your purchase for doing so. Each time you apply for credit is listed on your credit report as a “hard inquiry” and if you have too many within two years, your credit score will suffer.
Once you’ve fixed errors on your credit report, begun budgeting and paying off debts, be patient. It will take months or even a couple of years for your credit score to improve, but if you plan on buying a new home, it’s well worth it.