For starters on this topic, your credit report is more than just your scores. The scores are usually a good indicator of what's on the report, but not the final say. A low credit score could mean several different things about your total credit profile. Some problems are easier to resolve than others. Below are the most common problems that lower credit scores, paired with advice on how to deal with them.
One of the drains on your report might boil down to the balances you have on credit cards and loans. For instance, if you have a credit card with a limit of $2000 and the balance is $1800, that is going to negatively impact your score. If you have several accounts with high balances, it is likely your scores will be quite low. The reason behind this is that the credit bureaus view high balances as an indication that you are stretching your budget too far.
It is easier said than done, but paying as much as you possibly can to lower the balances on your credit cards will go toward improving your scores. If you can get the balances on each of your accounts to less than half of their limits, your scores will improve substantially. For a long-term strategy toward paying these accounts off, I highly recommend reading Dave Ramsey's book, The Total Money Makeover.
Perhaps the most common bad marks on credit reports are late payments. If you fail to make a payment on a loan, credit card or other debt within 30 days of the due date, most creditors will report your late payment to the credit bureaus. They will also report if the account goes 60 or 90 days past due, further subtracting points from your score. No matter how late these payments are, they are incredibly damaging to your scores.
Obviously, the best thing to do would be to avoid late payments at all costs. If you know you won't be able to afford the full payment for a month, call your creditor and make a payment arrangement. Often, even a token payment with advance approval from your creditor will prevent them from reporting your payment late. To your creditor, they would rather you be honest and pay a little, than to ignore the bill and miss it entirely. It can be a difficult phone call to make, but it is well worth it!
If you already have late payments on your report, that doesn't mean it's the end of the world. There is a big difference between one late payment and fifteen. One or two 30-day late payments, with a solid letter of explanation, may be excusable when you are applying for a mortgage. However, if you have missed ten payments over the last 12 months, then this shows a clear pattern of either financial irresponsibility or extreme hardship - neither of which looks good to the underwriter in charge of evaluating your loan application. If this scenario is similar to your situation, then you need to take a long view and plan a strategy.
Short of arguing with your creditors about the late payments, the best thing you can do is take the time to establish a new pattern of financial responsibility. If you pay your credit bills on time for 12 months and avoid any delinquencies, your score will be much better. When applying for a loan, the previous 12 months takes major precedence over poor performance before then. With a good 12 months of credit history behind you, you can often qualify for a good, market rate mortgage!
Worse than a late payment is a bill that simply goes unpaid. Collection accounts stay on your report indefinitely as the debt is sold over and over again to debt collection agencies - the old 'seven year' rule often does not apply! This practice of recycling your debt is certainly unfair, and possibly illegal in some cases, but if it stays on your report rightly or wrongly, it's hurting your scores.
Much like for late payments, the best action to take is prevention. Most reported collections can be avoided by simply communicating with your creditor - in the case of potential collections, do not let the first person you talk to scare you off. Keep asking to talk to a supervisor until you get someone who has the inclination and power to act in your favor. Once again, it is better to make payment arrangements than to avoid paying the bill.
Keep in mind, the only person you are hurting when you leave a bill unpaid is yourself. The company can often 'charge off' your missed payment to receive a tax benefit! It is in your best interest to do everything possible to avoid any account going into collections, regardless of who's fault it is or if you believe you were misled by the creditor in the first place. I talk to people all the time who tell me the reason they didn't pay the cable company or the phone company is because they didn't feel they were treated fairly. If you want to seek legal recourse, you will be in a much better position if you pay the debt and fight it later.
Another point to remember is that if your creditor does have to sell the debt to a collection agency, they often receive only pennies on every dollar originally owed. They would much rather receive the whole amount over time than a few dollars instantly.
Collections on your report are not automatic deal-breakers. Often, allowances are made for medical collections and some very small debts. Most collections, however, will pose as major problems in the mortgage qualification process. Due to complexities involved in how credit scores are generated, it is nearly impossible to issue any catch all advice for how to deal with collections once they are on your report. In some cases, due to the terribly unfair quirks of the system, coming to payment arrangements after collections are reported can dramatically lower your scores! Even paying the balance in full can be detrimental. Solutions to collection accounts once they are on your report are best handled on a case-by-case basis.
Distancing yourself from these collections by establishing a period of good credit for 12 months will put you in a much better position. Over time, these delinquent accounts affect your scores less and less.
If you do have open collections when applying for a mortgage, depending on how the underwriter views them within the context of your file, you might have to pay them off before closing on the loan. It is a good idea to save enough money that you have the ability to do this - just wait until you have consulted with your loan officer before you make payments of any kind.
If you have never opened a credit card and never paid on a loan, you might have no credit score at all. If you only have one account, even if you have made all your payments on time, your score might not be high enough to qualify for a mortgage. The credit bureaus are interested in your ability to juggle multiple debts effectively. Demonstrating payments on one loan will not be enough to establish a solid credit score. Likewise, if you have limited credit on your report and you do make a late payment, your score will be affected much more negatively than someone who has a lot of positive credit to compensate.
The ideal number of open, active credit accounts is anywhere between 3 and 7. I'd aim right in the middle for 4 or 5 accounts. What you are trying to do is establish a pattern of good payment history on multiple accounts. In order for a new account to really bolster your score in this way, it should be open for at least 12 months, with payments being made on it at least every few months. Some people funnel their daily expenses through one credit card, charge gas on another and use a third for the occasional treat. Just make sure you are able to pay off whatever you charge on the cards at the end of the month and you will be happily building positive credit without paying interest.
There is a lot of talk about having your credit report pulled and your scores going down dramatically because of the inquiry. For the most part, unless you are applying for every credit card under the sun and are already in serious credit trouble, you don't have much to worry about. The credit bureaus' logic behind lowering scores after a company makes an inquiry is to penalize people desperately fishing for new credit when already strapped for cash. If you have an average or a good credit score, you won't be penalized more than a few points, if at all. Even if you have low scores, one late payment will hurt your score much more dramatically.
Not surprisingly, huge bureaucracies like the three major credit agencies make mistakes. Another person's account might show up on your report. They may show you making a late payment that never happened. They could even report erroneous collections! The best way to handle mistakes on your credit report is to contact the credit bureaus to inform them about the error. If you have any documentation to support your side of the story, offer to send it to them. Your goal here is to have the credit bureaus begin an investigation into the disputed accounts.
You can actually hurt your scores by closing old accounts. If you haven't figured this out by now, the credit reporting system sometimes doesn't make a whole lot of sense. Without going into a great amount of detail, closing an account can probably only hurt your score. Keep accounts open, even if you don't use them to maintain the best credit profile.
The formulas credit bureaus use to determine your credit scores are very complex, but some common sense rules can keep your scores high. Pay your bills on time, keep your balances low, maintain active credit accounts and do not allow disputed debts to go into collections.
Contact me for a free credit report and to learn in more detail how you can improve your scores.
