Lenders look at your credit score when making important loan decisions, including those for personal loans. The higher your credit score, the better your financial standing when it comes to obtaining loans and credit extensions.
Here are the essentials of how to improve your credit score, common mistakes to avoid, and valuable credit improvement strategies.
Understanding the factors that affect credit score
Before diving into how to improve your credit score, which ranges between 300 and 850, it’s important to first know what factors influence your credit score. The five main factors are:
- Payment history
- Amounts owed
- Credit history
- Credit mix
- New credit
Most lenders look at your FICO credit score when making decisions related to your loan application, but they may also look at your VantageScore. Both scoring models operate similarly enough that the general ideas for improving credit scores remain effective.
Checking credit reports for errors and inaccuracies
Credit report errors and inaccuracies can lower your credit score, especially if you fail to notice and dispute them. That is why it is often a good idea to keep an eye out for unauthorized changes that show up by either checking your credit report regularly or using a credit monitoring service.
An error or inaccuracy may be an unauthorized hard inquiry, which can dip your credit score by around ten points each time. An information furnisher, the company that provides a credit bureau with your credit updates, might erroneously give a credit bureau the wrong information. The furnisher may also be maliciously providing incorrect information or making hard credit checks without your authorization. It might be worth contacting the furnisher of the incorrect information to get them to tell the credit bureaus to fix the mistake, but you might also need to dispute the errors yourself.
If you spot something on your credit report that is unexpected or you know should not be there, you should reach out to each of the credit bureaus to report the inaccuracy.
Paying bills on time to avoid late payments
A major factor that affects your credit score is whether you have been paying your bills on time. Missing a single payment can lower your credit score by around ten points, and in some cases, missing a payment can hurt your credit by a hundred points.
It is critical to make sure that you pay all of your bills on time. You can use software and applications to give you regular reminders on the day you need to make your loan and credit payments. Even a calendar or planner can go a long way in making sure that you don’t forget to pay your bills.
For personal loans, this usually means paying the monthly installment that was predetermined by the loan agreement.
For credit cards, this means at least paying the minimum balance required each month to keep your account in good standing. Of course, you should ideally pay as much as you comfortably can. If you end up unable to budget for your necessary expenses after paying a bill, it is advisable to reconsider your budget allocation.
What happens if I default on a loan?
Defaulting on your debt counts as a derogatory mark on your credit report. Derogatory marks are very concerning to lenders who are making the decision whether to grant you a personal loan because they show lenders that there is a high risk of you not repaying the loan.
While derogatory marks will eventually disappear from your credit report, they typically have a lasting impact of up to 7 years. Because of this, the best way to deal with a derogatory mark is to avoid it in the first place. The second best way is to try negotiating with your creditor to remove a mark from your credit report.
Reducing credit card balances to improve credit utilization ratio
Your credit utilization ratio refers to how much of your total available credit you are using currently. The higher your credit utilization ratio, the more likely a lender will see you as someone with a higher risk level, which is why it can negatively impact your credit score.
In order to lower your credit utilization ratio, you may want to work towards reducing your credit card balances. The ideal credit utilization should be kept below 30%.
First, you should find out what your total credit limits are across the board. Then, calculate what is 30% of your total available credit. This will help you determine what credit usage you should stay below for optimal credit utilization.
You will need to spend less money or pay down the account balance until it reaches an acceptable amount. This can help boost your credit score, especially if you manage to stay below a 30% credit utilization ratio for a long time.
Increasing credit limit to lower credit utilization ratio
Another way to lower your credit utilization ratio is to simply increase your total credit limits. That way, as long as you don’t significantly increase your credit usage, you should be able to fairly quickly bring down your credit utilization ratio.
To up your credit limit, you will need to contact the creditor associated with each credit account individually to request a credit limit extension. If a request gets approved, you will be able to increase your credit limit and more easily manage your credit utilization ratio. Note that your creditor’s customer service might reject your credit limit increase application because the increase is never guaranteed.
Avoiding opening too many new credit accounts at once
Even though having a variety of credit types can improve your credit mix, opening too many new credit accounts in a short period of time is risky behavior in the eyes of lenders.
If you can avoid creating too many credit accounts at once, it may be worth doing so. The general rule of thumb is to avoid opening a bunch of new credit accounts in a row. Instead, your credit mix should be expanded over time. This can also reduce the amount of money you spend on annual fees.
To help counter the need of opening new credit accounts for money to spend, you might want to consider alternative options.
For example, if you want to stop signing up for new credit cards, taking out a personal loan may be a valuable alternative to finance your necessities. A personal loan provides you with great flexibility and quick funds so that you can achieve the goal you want to reach.
Keeping old credit accounts open to maintain credit history length
A common mistake many people make is to immediately close their old credit accounts when they aren’t being actively used anymore. This is understandable because of the unintuitive effect of closing credit accounts on your credit score. Unfortunately, when you close any credit account, you may see your credit score drop. While this isn’t a heavy impact, you can still see your credit score dip by around five to six points.
Because of the negative impact on your credit score to close an account, you might want to keep old accounts open to increase the length of your credit history.
One caveat to this is that if your old credit account has a long streak of negative payment history, then you might want to close this account to help improve your overall standing.
Negotiating with creditors to remove negative marks on credit report
Negative marks on your credit report may last up to seven years. Depending on the type of mark, it can cause lasting damage to your credit score for a long time.
Serious negative events on your credit report are referred to as derogatory marks. These have a long-lasting impact on your credit score and can be hard to eliminate. Here are a few common types of derogatory marks on a credit report:
- Loan default
- Late payments
- Tax lien
- Account charge-off
- Debt sent to collections
- Repossession of collateral assets
While negotiating with your lender to get rid of a derogatory mark isn’t always possible or well-received, it may be worth the effort. As long as you can professionally explain your situation and why you’d like to reach a compromise, you could potentially convince the lender to remove the negative mark from your credit report.
Propose a settlement
Sometimes, proposing a settlement could be the way to go. A settlement agreement may mean that in exchange for removing the negative mark from your credit report, you pay a certain amount in settlement. Not every lender is willing to settle, but in general, creditors prefer receiving some amount of money back rather than none of it.
Writing a goodwill letter is one way to remove a late payment from your credit report. In a goodwill letter to your lender, you get the chance to explain why a payment was late and why the lender has any reason to wipe this late payment from your records.
An impactful goodwill letter should persuade the lender to empathize with your situation in a courteous and polite manner. It might help to accept responsibility for the missed payment and demonstrate that you will stay on track to make payments on time in the future.
Seeking professional credit counseling to develop a debt management plan
It’s natural to find debt management stressful and not know where to begin. Sometimes, the best choice might be to seek professional credit counseling. Here are a few of the benefits associated with getting expert guidance about debt management planning:
Credit counselors can create an individualized financial assessment: When you find information online, that will be generic help for those in your situation. If you seek an expert’s opinion for your own situation, the credit counselor will be able to review your particular case carefully and identify ways to improve your debt management. All of this is done while taking into account your personal debt situation, income, and expenses.
Credit counselors have insight into lenders and the market: While you might not be familiar with your lender’s company or policies, your credit counselor should be well informed of everything there is to know about your lender. This may even include having established relations with the lender so that they know how to best seek favorable loan terms. With a credit counselor, you might be able to more successfully negotiate loan terms.
You can receive emotional support and stress relief: Naturally, being in debt can take a toll on your emotional and overall well-being. Being in constant communication with your lender while you are behind on debt management can also be frustrating. A great benefit to seeking professional credit counseling is that you won’t be alone when it comes to dealing with your overwhelming debt. Credit counselors are professionals who can help equip you with the skills and knowledge you need to tackle your debt.
Being patient and consistent in credit score improvement efforts
As fantastic as it would be to see credit score improvement overnight, your efforts to boost your credit score need to be consistent over a period of time. After all, time (more specifically, credit history) is a factor that influences your credit score.
If you consistently make on-time payments, maintain a credit utilization ratio below 30%, pay your bills to keep a low credit card balance, and showcase an overall positive credit behavior, your credit score should gradually improve.
For those who have derogatory marks on their credit report, such as foreclosures, late payments, and bankruptcy, it can take an extended period of time before it is possible to rebuild trust with lenders. This process requires responsible financial behavior and debt management for a while to show that you’ve truly become more financially responsible.
An added benefit to improving your credit score over time is that you can also strengthen your financial discipline simultaneously. As you increase your credit score through patient, consistent efforts, you may notice your efforts positively impacting other financial aspects of your life. Budgeting and investing money can become easier since you are laying the foundation for healthy financial habits and behavior.
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