Do you need credit and credit scores?

No matter what banks and others tell you, you can actually live without credit and credit scores. However, it may become increasingly harder and harder to do this as we move forward into a more digital world. Digital transactions are pushing us all towards integrating with the financial industry and their various financial tools, including credit scores. The best advice, fundamentally for all of us, is to live within our means. Try to remove your high interest debts, pay off your credit cards in full each month; and save money whenever you can. Carrying out this small step, will set you on the path toward building wealth. Building true wealth, not credit scores, is the most important goal for the long term. You don’t need to worship the FICO score, as it is not “the be all and end all” in your life.

But in saying that, creditworthiness can have a significant effect on the quality of your life. Creditworthy people are more likely to gain access to lower cost financing compared to people with poor credit. This can provide them with a massive advantage in their lives, especially in US society, where financing can be the difference between success and failure. Despite this, not many people in the US have high credit ratings. The FICO credit score is often seen as the easiest measure of creditworthiness. The FICO score ranges between 300 and 850. If you want to know how to build credit fast, you need to know what these numbers mean first.

Here is a simple breakdown of FICO scores:

• 720 or more:   Excellent
• 660 – 719:       Average/Fair
• 620 – 659:       Poor
• 620 or lower: Bad

The average US FICO score in 2019 stands at 695. This is actually an all-time high, given the good economic climate in the country. However, this still falls within the “average” category. In other words, there are still a lot of Americans who need to work more on their creditworthiness in order to qualify for better rates with banks and other lenders.

What Goes Into Building Credit?

In order to build your credit, you will first need to understand what factors are considered in determining creditworthiness. This is essential, especially for people looking to learn how to rebuild bad credit or build up from no credit. At the moment, the US has three main credit reporting bureaus. These bureaus monitor your personal financial data on a regular basis. They include Equifax, Transunion, and Experian.

How is your FICO score determined?

There are five major factors that go into determining your credit score, and they are weighted as follows:

• 35% – Payment History
• 30% – Total Amount Owed
• 15% – Length of Credit History
• 10% – New Credit
• 10% – Types of Credit Used

Payment History – This is the most crucial part of the scoring system. It accounts for 35%. It measures how promptly you repay your debt. If you have ever been late with payments, your credit score will be affected negatively. This gets worse for people who have defaulted on their loans.

Credit Utilization – The amount that you borrow from your total available credit is another important determinant of credit score. It accounts for 30% in the scoring system. Utilizing more than 30% of your credit card’s limit can affect your credit score negatively. Maxing out credit cards (basically utilizing 100%) can severely harm your credit score.  Having more than one credit card where all cards are maxed out will severely harm your credit score as well.

Length of Credit History – This metric simply looks at the amount of time you have been using credit. This accounts for 15% in the scoring system. Lenders like to see that you have been using credit responsibly for a long period of time. Therefore, keeping your first credit card active, even if you don’t regularly use it, can help boost this metric.

New Credit – This measures what percentage of your debts is new. It accounts for 10% of the overall score. Recently opening several new credit card accounts, for example, will reduce your credit age. A big percentage of new debt can negatively affect your overall rating. However, the impact is often small to minimal.

Types of Credit Used – There are different types of credit. Retail credit, credit card debt, mortgages, and student loans are some of the most common ones. This accounts for 10% in the scoring system. Having a diverse pool of debt could help improve your score, by showing that you are able to manage different types of debt. However, the overall impact on the final score is not that high.

It’s important to note that the three bureaus don’t use a universal credit reporting system. In addition to this, some lenders may report to one bureau and fail to do so for the other two. As a result, the credit score assigned by the three agencies will vary. Nonetheless, if you have a good score in one bureau, it’s very likely that you will fall in the same category for the other two as well.

How to Rebuild Your Credit

When you understand the factors that go towards determining your creditworthiness, you can gain a rough idea of what needs to be done to improve your overall score. For example, you can work on paying your monthly credit bills in full, or utilize less credit debt. However, there are other specific methods that you can take to achieve results fast.

Check for Possible Errors

Credit reports are not always 100% accurate. There might be a few errors in reporting that may reduce your chances of rebuilding your credit. In that case, it is important to regularly review your credit report and see whether there are some mistakes.

Identity errors are often the most common in credit reports. This is where different accounts belonging to someone else with a similar name are mistaken as yours. In some cases, you may see a single loan account appearing more than once in the report. The sooner these mistakes are fixed the better.

Steps to do to help with this:

1. Get a copy of your credit report: free credit scores are available from www.annualcreditreport.com, Credit Sesame and Credit Karma.
2. Identify the negative accounts
3. Dispute every negative item on your report
4. Dispute credit inquiries

Keep Your Credit Card Balance Low

The temptation of using credit cards to shop is always high. The convenience of credit cards also means that it is easy to get carried away with spending. The rule of thumb is to keep credit card balances below 15% to 30% of the total limit of the card. This ensures that you are not over utilizing your credit. Strive to always pay down your credit card bills in full every month.

Paying off Debts

If you have enough money to settle your debts, begin the process of working with collection agencies that may have contacted you. Work with them collaboratively, to have them to remove any credit hits against your credit report. Once you pay off the debt, collection agencies should have the ability to remove the account from your credit report. If the collection agency refuses, you should not pay them.

Debt Validation Letters

If you are contacted by debt collectors, you can respond to them with a debt validation letter. A debt validation letter forces debt collectors to prove that you owe them a debt. This process can help remove old collections from your credit report. A debt validation letter is a letter that simply demands that the collection agency send you proof through documentation that you owe a debt. This documentation normally comes from the original creditor. The interesting fact about old debt is that debt collectors regularly buy and sell debts with other debt collectors. Because of this, the current debt collector might actually have a hard time validating the debt. A debt validation letter can be used on old debts to get the debt collectors to stop calling, and can also be used to remove bad scores on a credit report. An important note with this method is that you only have 30 days from the first time a debt collector contacts you to send them the letter of request.

What Does a Debt Validation Letter Look Like?

Here is a sample template for a Debt Validation Letter:

[Current Date]

[Name of Collection Agency or Creditor]

[Creditor Address]

RE: (Account Type) account # (full account number) (and if you have any additional account numbers assigned by the collection agencies – you can find these in collection letters)

I formally request that you validate all notations you have submitted to any credit reporting agencies by [Name of Collection Agency or Creditor] for me, [NAME], for account number XXXXXXXXX.

Due to possible inaccuracies in these credit reporting agency reports; I hereby lawfully request the validation be in the form of a notarized statement by a person with original knowledge of the debt as it was constituted and who can testify that the debt was incurred legally.

Please know that you have 30 days from the confirmed delivery of this notice to either answer these demands or to remove the associated negative trade line notations from the credit reporting agency reports.

Sincerely yours,

Your Name

[Address]

Create a Relationship with Your Banks

Many lenders will often send favorable reports to credit rating bureaus if they have a good relationship with the borrower. Even in cases where payments are late, the bank can overlook this as long as there is an established relationship with the client. Remember, your overall credit score is based on the data reported by banks. If your lender is a little lenient, you may be able to maintain a good score.

Consider Refinancing

Refinancing is the process of obtaining a new loan to repay existing debts. You may be able to refinance to get better terms. Refinancing is offered by most banks and can be done on any type of loan. You may want to use refinancing to pay off multiple high interest debts and consolidate your borrowing under a larger loan with lower rates. The biggest advantage to refinancing is that you will be able to get rid of bad debts and start fresh again. As long as you stick to your new payment schedule, you can utilize your new loan to help rebuild your credit.

Rebuilding your credit score can be very difficult in some cases. However, the most important thing is to take it step-by-step and stick to a budget that is well within your means. For people wondering how to repair credit, simple things like paying your bills on time and avoiding too much credit card debt are the key to improving your credit score and building long term wealth.