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How to Understand and Improve Your Bad Credit Score

Tuesday, May 6th, 2014

Are you frustrated with your poor credit score? You have every right to be. Perhaps you should also take some time to understand what influences this rating and what you can do to improve it. Dire as your situation may seem right now, a bad credit rating is not set in stone and can definitely be improved over time.

What influences your credit score?

How the Credit Bureaus Determine Your Credit Score

Credit ScoreIf your goal is to have a good credit score, then you need to first find out how the credit index is calculated. There are actually several scoring methods out there. Since all the three main credit bureaus in the U.S. worked with the Fair Isaac Corporation in the 80s, it makes sense that Experian, Equifax and TransUnion should all employ the FICO method or a variation of it. Equifax uses BEACON, TransUnion uses the classic FICO method, and Experian’s system is called Experian/Fair Isaac RISK. This method assigns a certain ‘weight’ (expressed in percentage points below) to each of the factors that contribute to your personal rating.

The credit score range runs from 300 to 850, so if you’re wondering ‘what is a good credit score?’ your answer is somewhere towards the higher end of that segment. While the Fair Isaac Corporation owns the rights to the calculation formula and is keeping it a secret, you can still determine your score (with some degree of approximation) by taking into account the following factors:

The Factors that Influence Your Credit Score

Payment History

Debtors with a good history of paying back money to their lenders (in full and on time) tend to rank the highest on the credit score scale. This high ranking is due to the fact that payment history makes up about 35 percent of a person’s score. Bankruptcies, bills sent out for collection and bills paid on time all affect your track record. The most recent unpaid bills weigh heavier than older ones in terms of the negative impact on your score.

Outstanding Debt

Owe any money on mortgages, car loans, or credit cards? All this debt will amount to 30 per cent of your credit score. Credit cards are particularly sensitive. By and large, their balance should be constantly maintained around 25 percent.

Credit History

Contrary to what you may think, the longer you’ve had a credit line open the better. The length of your credit history amounts to 15 percent of your credit score. Lenders take your past behaviors into account when trying to predict your future actions. The more data they have at their disposal the better your odds are of having a good credit score.

New Credit

At the same time, opening a new line of credit will take a slight negative toll on your credit rating. That’s because opening a new credit account will usually involve a hard inquiry from a lender who will look at your credit situation over the past year. 10 per cent of your credit rating is determined by new credit/hard inquiries.

Credit Types

10 percent of your credit score is directly determined by the types of credit you have. The more, the better off you are. A wide range of different types of loans shows lenders you can handle various credit accounts and are accustomed to what they entail.

Can you Improve Your Bad Credit Score? Yes, you can!

Now you know a few things about credit score ranges and the factors that affect your rating. You might still be in the dark as to what you can do to improve a poor score. Here are five tips to take into account:

  1. Make sure your credit reports are accurate. Surveys suggest that some 25 per cent of all credit reports contain mistakes that negatively impact one’s score. Make sure to verify the data with information from all three credit bureaus and address any mistakes you come across.
  2. Hold on to your old loans. The average age of your credit accounts, as well as your credit limit can both improve your credit score.
  3. Clean up your (balance) act. Your balance should stand at 75 percent (or less) on all your credit lines. Aim for 25 percent.
  4. Avoid hard inquiries. The higher the number of hard inquiries on your credit report, the lower your rating will be. So don’t let anyone make such inquiries on your behalf – but do make several within a short span of time if you’re shopping for a new loan. In such scenarios, several hard inquiries will show up as just one on your report.
  5. Pay your bills! This is the single most effective (and simplest) way to improve your credit score. Why? Because, nothing weighs heavier in calculating credit ratings than your credit history.