None of us is perfect…we’ve all made financial mistakes at some point or another, myself included (maybe more than most). And, we’ve had it beaten into our heads the importance that a certain three-digit number has in our lives.
The Dilemma – Credit Behaving Badly
Of course, I’m referring to our credit score. It’s truly very important – from the interest rates we pay on mortgages and loans to whether or not we are approved to buy a house or rent an apartment, even whether or not we can land a second interview for a new job. Much of adulting revolves around how our credit score looks.
But what happens if and when we inevitably make mistakes that damage our credit? Are we doomed to a lifetime of frustrations, regret, and financial catastrophe? Let’s explore life after financial screw-ups, and, more importantly, how to get back on track and seize control of your financial future and prosperity.
Defining Our Credit Score – A Primer/Review
Before we can identify where we went wrong and where we are aiming to go, let’s go over credit score basics:
Score Range: 300-850
We are playing in the adulting world, so let’s get accustomed to our “grading scale.” Sub-650 is generally considered poor, which means that lenders view you as a high risk to not repay loans. Therefore, borrowers at this end of the spectrum tend to pay higher interest rates on loans and credit products…much higher.
Factors that make up our score
So, this all-powerful credit score, how is it calculated, exactly? I’m glad you asked, Stacker! By understanding how it’s created, we can reverse engineer it and improve it most efficiently.
From highest weighting to lowest, the credit score contributors are:
- 35%: Payment History – have you missed any payments? Pay all your credit lines on time! Try not to miss any payments, if possible.
- 30%: Amount owed (as a percentage of available credit) – how much of your total available credit are you using? To calculate, divide the current amount owed by the total credit available from all sources.
- 15% Credit History – How long have you had your credit account(s) opened?
- 10% Types of Credit – How many different types of credit do you have?
- 10% New Credit Inquiries – How many times have you applied for credit recently?
It’s easy to mess up
Yes, it’s easy to make mistakes. We are not perfect, and mistakes do happen. You might overspend and kill your debt to available credit ratio, forget to make a payment and ding your payment history, only have one or two types of credit lines opened, or have made multiple requests for new credit over the past few months.
So, what’s a Stacker to do…?
Never fear! Let me walk you through some potential solutions for each mistake.
This is tough to fix after the fact. It’s much better to take action before you miss a payment. We recommend setting up automatic payments to each credit account. This way, you’ll be sure to never miss a payment and suffer the wrath of the highest credit score factor getting dinged.
There are multiple tools available to ensure you don’t miss payments. At the very least, set up an auto-draft from your bank account to the credit account for the minimum payment each month.
Given the weight that this factor carries in calculating your overall credit score, it’s important to pay attention!
Pro tip: We like the tool Qube Money (Show Sponsor) to budget. It works like the old envelope system – put the month’s expenses into the account, broken down by category, and when the money is out in X category, that’s it until next month.
High percentage of available credit utilized
While it may seem counterintuitive, opening new credit accounts will actually decrease the percentage of available credit used. More available credit and the same/decreasing used credit balance equals a lower credit utilization percentage. Bingo!
Just don’t go around opening a ton of new credit cards and max them out. Actually, don’t even spend the new money.
Pro tip: Dive deeper into other sources of credit by looking at a credit builder loan. What is a credit builder loan? Credit-builder loans are a unique type of credit account that can help people with bad credit or no credit history start to build (or rebuild) credit. Check out this detailed explanation: Credit Strong and Self.
Short credit history
Unfortunately, there are no quick fixes to speed time up and have a longer credit history. This is another example of when planning ahead will pay dividends.
Only one type of credit on your credit report
Now, I’m not suggesting you apply for every conceivable credit type out there for the sole purpose of improving this component of your credit score. However, it demonstrates that you have your act together with potential lenders if you maintain multiple credit account types (think credit card, mortgage, auto loan, business loan, etc.).
You are in the market to borrow money and are applying for multiple sources of credit
While this is a relatively minor component of your credit profile, applying for new credit (a “hard inquiry”) can be a red flag to lenders, as it could potentially demonstrate risky behavior. Plus, by opening new credit accounts, hurts the average age of your accounts.
Shrewd Stacker Takeaways
The whole credit scene is a tricky game. By using credit responsibly, having multiple sources of credit readily available but never approaching your credit limits, and demonstrating responsible behaviors over time, you can absolutely leverage your credit as another tool in your wealth-building arsenal.
What do you think?
What stories do you have that others could benefit from? Share your experiences with us in the comments below.