When it comes to shopping for a loan, few things are going to impact your ability to find what you’re looking for, with an interest rate that you can afford, as your credit score. In fact, credit scores are almost always the first thing that a lender will analyze when they are determining whether or not to finance your loan. Aside from the loans you’re trying to get now, low credit scores can also impact future loans you’re trying to get, such as a mortgage for your dream home or helping to pay for your children’s higher education. Credit scores are that important.
Although having a low credit score doesn’t mean you’ll never be able to get a loan, it can make it significantly harder to find a lender that will be willing to finance your loan and give you a competitive interest rate. If you have a low to mid-range credit score, it is critical that you understand what habits you have that are bringing your score down, and take steps to improve them.
The first, and most damaging, reason your credit scores are low is if you are missing your payments. When you take out a loan, be it for a car, a mortgage, a trip, or for college, you are pledging to your lender that you will pay back the amount you’ve agreed to. Another way to look at credit is as a promise from you to your credit provider that you will pay them back for investing in you.
When you miss a payment, you are broadcasting to lenders, banks and credit card companies that you have run out of money, something has gone wrong in your life that may impact future payments, or that you simply don’t care about honoring your agreement. All of these are ample reasons for your score to drop, and for lenders to refuse to work with you.
Slightly less detrimental, but still very serious, are late payments. While getting the money later than never is better to a lender, it still bodes ill for you. Late payments cause lenders to ask questions such as, “What’s going on with the borrower? Are they in some kind of trouble? Will they miss future payments? Will they be able to pay the loan off in full?” Anytime a lender or credit agency loses faith in you, it’s going to negatively affect your credit score.
Everyone goes through crises in life, and things happen that can cause you to be late on a payment. Most people, including lenders and credit scorers, understand this, and so long as it’s no more than once or twice over the life of a loan or a line of credit, you can recover fairly easily, provided you make your payments on time from then on.
Nearly everyone enjoys having nice things in life; we all want to have nice cars, a new computer, a bigger house, or treat our families to a vacation or a fancy dinner now and then. However, if you’re not careful, this can lead to serious trouble in regards to your credit score.
Spending more than you can afford or constantly owing money isn’t good under any circumstances, but it’s especially degenerative to your credit score. High debt indicates that you are potentially an irresponsible person who seeks out what they want without regard to how you’ll afford them.
If your credit limit on one of your cards is $10,000, and you have used $6,000 on your card, you’ve used 60% of your credit, which tells credit providers that you are relying on money that you may not necessarily have. Always strive to spend no more than 30% of your credit limit.
If you have a low credit score, it’s critical to explore options of reducing your debt.
One of the least understood factors that affects your credit score is your credit diversity. When any of the three major credit companies determine your credit score, one of the factors they consider are what types of credit you have, and how well you manage all of them. Different types of credit can include installment loans (such car loans, college loans and furniture purchases), mortgages, bank credit cards, retail credit cards, and rental data
To illustrate this point, consider the following: a middle-aged father of two has a mortgage, along with a car loan and school loans he’s paying for his child, as well as a credit card at his gas station and for where he buys groceries. Conversely, think about a new college graduate, who received a full-tuition scholarship and has no student loans, who has just entered the workforce and only has a single credit card.
In all likelihood, the middle-aged father will have a higher credit score, because he has multiple types of credit that he has managed successfully. From a common sense perspective, and especially in the eyes of a potential lender, the father is much more likely to be able to handle an additional loan because he’s done so for different types of credit. The college graduate is a higher risk because he doesn’t have multiple accounts to draw from and hasn’t demonstrated that he can manage different credit requirements.
So does this mean you should go right now and seek out a mortgage or to buy a new car to add more diversity and improve your score? Of course not. More often than not, adding one to two new credit accounts, such as a credit card from where you buy your gas, or a card from where you buy most of your clothes, is more than enough to improve your score. In fact, credit companies will lower your score if you attempt to open too many accounts all at once, because it makes you look desperate for credit, so be prudent when you decide what credit accounts to open.
Short Credit History
One of the factors that can lead to a low score, and what is probably the most frustrating, is having a short credit history. Credit history refers to how old a line of credit is, the payment history, and how often it’s utilized. The reason this can be the most frustrating of the different factors is because you’re limited in how much you can do to have an immediate impact. Simply put, you can’t suddenly build a long history of responsible credit use. It takes time and careful monitoring.
In order to generate a FICO score, a line of credit has to be open for at least six months. In the grand scheme of things, this isn’t a great deal of time, but when you desperately need approval for a loan right now, it can be very discouraging.
When it comes to having a successful credit history, the best thing you can do right now is to ensure that you’re only using credit that you can afford, while being as diverse as possible, and that you make your payments on time, every time.
One of the biggest factors that can affect your credit score is your level of debt versus how much you have to spend. When working with lenders and credit agencies, this is referred as your Debt to Income ratio, or DTI. Your DTI is a percentage that is calculated by dividing your expenses against how much money you make.
For example, if you have $20,000 in expenses a year, and make $30,000 a year in household income, your DTI would be 66%. Lenders and credit agencies consider an average DTI to be between 15 to 33%, and most lenders will be very hesitant to work with you if your DTI is above 43%.
Lenders want to ensure that you are able to make your minimum payments and repay the loan in full. If you’re already spending most of what you have on things besides a new loan, you present a much higher risk of not being able to pay.
The best solution to improve your score in this regard is to simply be frugal with your expenses. Consider a lower cost apartment that may not have as much space as you’d like, but that you can easily afford, or buying a used car at a cheaper rate, so long as it’s reliable. In short, live well within your means.
Credit scores can be a tricky thing, and if you’re suffering because of a low score, it can severely reduce your quality of life. As you progress, bear in mind the six factors we discussed, and take a good, hard look at yourself and your circumstances. Once you’ve determined what’s bringing your score down, make every effort that you can to actively improve your credit score.
The most important thing to remember is to not be discouraged by your bad credit; it may be making things difficult for now, but it’s something that you play and active role in, and therefore, it’s something that you can improve.