Your personal credit score is an important three-digit number that creditors review during the loan application process. This number also comes up in other areas like tenant applications, utility bills, and other factors. A poor credit score can give you fewer opportunities and increase your expenses, but it’s possible to turn a bad credit score into a good one. This guide will show you how.
How Credit Scores Are Calculated
Five key components make up your credit score. Since your credit report offers a snapshot of how well you can do among financial obligations, payment history is the most critical factor. Here’s the breakdown:
- Payment history: 35% of your score
- Credit utilization ratio: 30% of your score
- Length of credit history: 15% of your score
- Credit mix: 10% of your score
- New credit: 10% of your score
Why Your Credit Score Matters
Your credit score plays a significant role in determining the amount of money you can borrow and the annual percentage rate (APR) applicable to your loan. A lower credit score often leads to a higher interest rate. Furthermore, poor credit can impede your ability to secure a lease agreement and may result in elevated utility expenses.
Numerous financial institutions, including banks, credit unions, and online lenders, enforce minimum credit score prerequisites for various financial products such as personal loans. While obtaining a loan with a suboptimal credit score is feasible, such financial instruments generally entail higher associated costs.
What Causes a Low Credit Score?
A low credit score mostly boils down to a bad payment history, but there’s more to it than that. These are the factors that can result in a low credit score.
Late or Missed Payments
Any late payments will have a negative impact on your credit score, and they will remain for seven years. While one missed payment will have a reduced impact on your credit over time, making them a common occurrence can meaningfully drag down your credit score.
High Credit Utilization
Credit utilization represents 30% of your credit score, and a higher ratio will hurt your FICO score. This metric measures the percentage of your credit limit that you have borrowed against. If you have a $5,000 credit limit and have borrowed $2,000 against it, you have a 40% credit utilization ratio. A credit utilization ratio under 30% can improve your score, but it’s optimal to get your credit utilization ratio below 10%.
Frequent Credit Inquiries
Most creditors run a hard credit check if you apply for a loan or line of credit. While a single hard credit inquiry won’t do much damage to your credit, regularly applying for loans and credit cards will lower your credit score.
Limited Credit History
If you don’t have much credit history, you won’t have the best credit. Building a credit history with a credit card or a loan can get you on the right path and lead to a higher credit score.
Errors on Credit Reports
The major credit bureaus aren’t perfect. If you find an error on your credit report, such as an early payment that shows up as a late payment, you can dispute it so it won’t have a negative impact moving forward.
The Impact of a Low Credit Score
It’s essential to get your credit score to a good level, preferably a FICO score above 620. These are some of the reasons why.
Higher Interest Rates
Creditors view borrowers with low credit scores as higher risks. Lenders and credit card issuers will compensate for the elevated risk by setting higher interest rates, resulting in higher monthly bills.
Difficulty Getting Approved for Loans
Some lenders will reject your application if your credit score is below 620. While FHA loans are available for aspiring homebuyers with 500 FICO scores (if they can make a 10% down payment), you will have fewer options if you have bad credit.
Increased Insurance Premiums
Insurance companies also raise their prices on consumers who have bad credit. The logic is that someone with bad credit may be more likely to cancel their policy, so insurance companies want to collect as much money as possible. Hence the higher premiums.
Challenges in Renting a Home
Landlords want predictable monthly payments to keep up with the mortgage. If they see that you have a low credit score and a history of missed payments, they may not want to work with you. Landlords who accept your application may request that you make higher monthly payments.
Employment Implications
Some employers review your credit history during the application process to see how well you manage your finances and responsibilities in general. It’s possible for a low FICO score to result in lost job opportunities.
Myths About Low Credit Scores
While credit scores are important, it’s important not to let some myths impact the way you view building credit. These are some of the common myths to keep in mind.
Myth: Checking Your Own Credit Lowers the Score
You can check your credit score at any time without any impact on your credit score. You can request a free copy of your credit report from each of the major credit bureaus — Experian, Equifax, and TransUnion — each year.
Myth: Closing Old Accounts Improves Credit Scores
Getting rid of old accounts does not help your credit score. In fact, you can end up with a lower credit score by closing old accounts. That’s because you will increase your credit utilization ratio and decrease the average age of your credit accounts.
Myth: Paying Off Debts Erases History
While paying off debt is good, any late payments will still appear on your credit report for seven years. Debt repayment will improve your credit utilization ratio, so you’ll still see a credit boost if you pay it off.
How to Improve a Low Credit Score
Consumers have several ways to boost their low credit scores. These are some of the methods you can try.
Review and Correct Credit Report Errors
You can request a free copy of your credit report and check it for any errors. Filing disputes with the major credit bureaus and providing that there is a mistake on your credit report can result in a higher credit score.
Pay Bills on Time
This is the best way to improve your credit score since payment history makes up 35% of your FICO score. If you spend less than you make, you should be better positioned to pay your bills on time.
Reduce Credit Card Balances
Making more than the minimum monthly payment will get you closer to having no balance on your credit card. Reducing credit card debt lowers your credit utilization ratio.
Avoid Opening New Credit Accounts
You shouldn’t rush to open new credit accounts, especially if you plan to apply for a mortgage or another significant loan within a few months. Not applying for more credit allows you to avoid hard credit checks.
Consider a Secured Credit Card
A secured credit card can give you a starting point for rebuilding credit. These cards are easier to obtain since you only have to make a security deposit. Secured credit cards have fewer perks, but they give people with bad credit the opportunity to start over. Once you have a sufficient credit score, you can upgrade to an unsecured credit card.
Other Strategies to Improve a Low Credit Score
While those basic tactics will help, these are some of the other strategies you can use to add more points to your credit score.
Budgeting and Expense Tracking
Monitoring your expenses and tracking your budget can reveal opportunities to save money. You may discover an unused subscription or unnecessary expenses that you can trim. Then, you’ll have fewer expenses and more money to pay off your credit card debt.
Seeking Financial Counseling
A financial counselor can offer guidance and accountability, so you stay on track with building credit. You can read a financial counselor’s online reviews to gauge the value of their advice.
Debt Consolidation Options
Debt consolidation allows you to group all of your financial obligations under a single loan. Debt consolidation can help you secure a lower APR, especially if you are consolidating credit card debt.
Exploring Companies That Can Improve Your Credit
Some credit repair services can help you add points to your credit score. These services offer consultations and dispute any errors on your credit report with the major credit bureaus.
If you’re facing discrepancies or errors on your credit report, it’s crucial to address them promptly. The Credit Pros specialize in rectifying errors and disputes, providing the guidance necessary to improve your credit score. Their team of credit professionals is committed to ensuring that your credit report accurately reflects your financial history.
Don’t let a low credit score keep you from achieving your financial goals. Contact The Credit Pros at (727) 306-8201 or fill out a quick form for a consultation—there’s no obligation required. With their 100% 90-day money-back guarantee and flexible pricing without long-term contracts, you can rest assured that you’re making a sound investment in your financial future.
