Rebuild
your credit, if necessary
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Problems caused by bad
credit
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1. Inability to get a loan
2. Higher interest rate if you do
get the loan
3. Larger down payment required if
you do get the loan
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Lenders will check your credit
record to see whether they're willing to loan you
money, AND to see what interest rate to charge you.
Bad credit doesn't necessarily mean that
you can't get a loan, but it does mean that you'll
pay a higher interest rate, and you may have to
have a larger down payment than otherwise. This
bears repeating: Bad credit doesn't just mean you
might not get the loan in the first place, it means
that if you do get the loan, you'll have to
pay more interest, and you'll be required to make a
larger down payment.
Here's an example from MyFico.com in August 2006
about how credit scores might affect the interest
rate -- and therefore the cost of the loan -- on a
30-year, $216,000, fixed-rate mortgage.
Ways to GET your
FICO credit score
#1:
See if your credit card company offers it
for free.
For example,
Providian gives cardholders their FICO
score based on their TransUnion or
Experian report every month.
#2:
Buy your FICO score based on
Equifax.
Equifax is the
only CRA that will sell you your FICO
score based on their report. (TransUnion
and Experian won't.) Get
your FICO score from Equifax for
$16.
#3:
Buy all three FICO scores.
The only place
to buy your FICO score based on all three
CRA reports is MyFico.com,
for $48.
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Credit Score
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Interest
Rate
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Monthly
Payment
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760 - 850
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6.33%
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$1,342
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700 - 759
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6.56%
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$1,373
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680 - 699
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6.73%
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$1,398
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660 - 679
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6.95%
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$1,429
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640 - 659
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7.38%
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$1,492
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620 - 639
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7.92%
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$1,573
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Consumer
Reports in June 2005 came up with similar
figures. They also said, "Over the life of
[a $150,000] loan, the people with the best
credit scores may pay roughly $138,000 less than
those with the worst."
The median U.S. score is 723. Here's how
the American population's credit scores stack
up.
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Credit Score
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Percentage of population
with this score
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800+
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13%
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750 - 799
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27%
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700 - 749
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18%
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650 - 699
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15%
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600 - 649
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12%
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550 - 599
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8%
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500 - 549
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5%
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less than 500
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2%
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From MyFico.com, Aug.
2006
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Credit Report vs. Credit
Score
Your credit report and your
credit score are two different
things. Your credit report is a list
of things like your credit card and bank
accounts, outstanding loans, and your payment
history. Your credit score is a rating of
how good your credit is, based on your report.
In other words, your credit report is a bunch of
pages, and your credit score is a number from
300 to 850. We'll cover the score later on.
Right now, let's focus on the report.
The main things on your credit report that
hurt your credit score are:
- Bankruptcy
- Outstanding (unpaid) debts
- Late payments
- Credit card balances near the credit
limit on those cards
- Liens (both outstanding and paid)
You increase your credit score by fixing
these problems. If there are troubling items
on your credit report you should try clear them
up, before you apply for a loan.
That's what the rest of this page is about.
You actually have three
credit reports
The companies that keep track of
your credit report are called credit reporting
agencies (CRA's). There are three of them:
Trans
Union,
Equifax,
and Experian.
So you actually have three credit
reports, since there are three CRA's that track
your credit, and your report can differ from one
CRA to the next. If you were late making
some payment, your creditor might report that
payment to one company but not the other two.
This means that if you need to clean up your
credit report, you probably have to clean up
three different credit reports. You never know
which CRA your lender is going to consult about
your credit (although some lenders will tell you
if you ask). Many lenders consult all three
CRA's, too.
Kinds of credit
scores
The most common kind of credit score
is the FICO score, which is calculated by a
company called Fair Isaac. Fair Isaac makes its
money by selling the FICO scores on individual
consumers to banks. When your bank buys a credit
report from a CRA like TransUnion, it also buys
the FICO score calculated from the TransUnion
report. Since you have three different credit
reports, you also have three different FICO
scores. In fact, your bank might order all three
scores.
While the FICO score is the most common,
the three CRA's each have their own scores that
they try to sell to the banks. TransUnion
sells a "TransRisk" score and Experian sells a
"ScoreX" score. Banks generally use the FICO
score because it's the industry standard, but
some banks might go with the CRA brand because
it's cheaper.
Many banks have also devised their own
system to calculate credit scores from credit
reports. That way they don't have to pay
anyone for the credit score.
So there are potentially seven different
scores your lender might see:
- The FICO score from the three CRA's
- The proprietary score from the three
CRA's
- The lender's own internal score
So what does this mean to you? It
means that if you're checking your credit score,
you need to know what kind of scores exist so
you know which ones to check. Of course, you
might not need to check your credit score at
all, if you're already sure your credit is good.
That's our next topic.
Do I need to find out my
credit scores?
Here's the catch: You want your
credit score to be high so you can get a loan at
a good interest rate. Unfortunately, you
probably can't find out your credit score
without paying for it ($16-$48). So here are
your options. We'll assume your lender is using
FICO scores.
- You can just buy them. $16 or $48
is a minor cost in the scheme of a $150,000
house. You can just pay to get your credit
score(s) and get it over with. You can get
your
FICO score based on your Equifax report
for $16, or you can all three FICO credit
scores from MyFico.com
for $48.
- See if your credit card company will
give you your score. Providian gives
cardholders their FICO score from TransUnion
once a month. This doesn't tell you the FICO
scores from the other two CRA's, but they're
usually pretty similar.
- Verify that your credit reports are
clean, because in that case you know your
score must be good. Get your three credit
reports for free from AnnualCreditReport.com.
By law, each CRA has to give you a free copy
of your credit report once a year if you ask
for it. If there are no items marked
"Derogatory" or "Negative", then your score
is probably pretty good and you can proceed
to apply for a loan. Even if you know that
you have negative items on your reports,
order them anyway so you know exactly what's
being reported.
- Ask your lender once they've run your
credit. Getting your credit scores
after you've applied for a loan is
kind of like putting your seatbelt on after
you've already had a wreck, but if you've
already applied for a loan and are curious to
know your scores, your lender may tell
you.
Beware of websites offering to sell you
"your credit score" (or give it to you free
if you buy some other service). Most times this
is a proprietary CRA score, not the genuine FICO
score.
Equifax
is the only CRA that will sell you your genuine
FICO score based on their report ($16)
TransUnion and Experian won't sell you a real
FICO score, they only sell their own proprietary
scores. If you want FICO scores based on all
three CRA reports, the only place to get them is
MyFico.com,
for $48.
Do I need to improve my
credit score?
That depends on how good your credit
is, of course.
Excellent credit. If you know
that each of your credit scores is 760 or
higher, your credit is excellent and there's
no need to try to improve your score.
Good credit. If your scores are
between 700 and 759, then you have a choice:
cleaning up you reports and getting your
scores about 760 will get you a slightly
higher interest rate, but not much. (See the
table above.) So it's up to you whether it's
worth your time in trying to improve your
credit rating.
Fair to Bad credit. If your scores
are less than 700, or if you don't know your
scores but you have your credit reports and
can see that they list negative items, then
it's time to start rebuilding your credit.
That's our next time.
Should I wait for an item
to expire off my report before I apply for a
loan?
Late payments are removed from your
credit report once they're over 7 years old.
Bankruptcies are removed after ten. If it's only
going to take a few months for a negative item
to expire off your report, and you don't have a
specific dream house in mind that you want to
buy right now, then sure, go ahead and wait for
the bad item to expire before applying for a
loan, so you'll have a higher credit score and
get a better interest rate.
But what if you have found your
dream house that's on the market right now?
If you don't buy it now, someone else will
probably buy it while you're waiting for your
credit report to improve. In this case, figure
out how much extra you'll pay because of the
higher interest rate, and see if you're willing
to pay that premium in order to get your dream
house. And remember that once your score
improves, you can always refinance at a better
rate later on.
If it's going to take a couple of years
for your credit score to improve, and you're
able to get a loan now, you should probably do
so rather than wait. Yes, you'll pay more
interest, but you'll start your investment in
your house that much sooner, which will balance
out the extra interest you'll pay. And once your
credit score improves, you can always refinance
at a lower rate.
Credit scoring
myths
Myth:
Checking my credit score or getting my
credit report hurts my credit
score.
FACT:
No, it doesn't. Inquiries about your
report for the purpose of establishing
new credit can decrease your score,
but inquiries to just get your score or a
copy of your report never hurt your score.
And even though inquiries for the purpose
of establishing new credit reduce your
score, they don't reduce it by very
much.
Myth:
Closing credit card or merchant accounts
will help my credit score.
FACT:
Closing accounts generally won't raise
your score. People have heard, quite
correctly, that sometimes having too many
open accounts can hurt your score. That's
true, but once you already have the open
accounts it's too late. If you close
accounts now then your ratio of
outstanding debt to credit available will
rise, which will probably
negatively impact your score.
Now, if your
lender asks you to close an account
or two as a condition of getting the loan,
then go ahead and do so. You're not doing
so to raise your score, because it
doesn't, you're doing so because your
lender says that what it takes for you to
get the loan. The reason they might do
this is because they're afraid if you max
out all your various cards you'll be
spread too thin and won't be able to pay
back the mortgage. So they may want you to
close an account or two to reduce your
ability to rack up more debt. But you
should close accounts only if your
lender says you need to do so in
order to get the loan. If a mortgage
broker suggests you do so, ignore
them.
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Ways to IMPROVE
your FICO credit score
#1:
Start paying all bills on time, from here
on out.
#2:
Pay off any outstanding amounts you
owe.
#3:
Correct any mistakes on your
report.
#4:
Ensure negative items older than 7 years
aren't reported.
#5:
Add your side of the story.
#6:
Pay down debts.
#7:
Don't apply for new credit unless you
really need it.
#8:
Get and use a credit card if you don't
have one. (Buy only things you would
have bought anyway, like groceries.)
See
more
details about the above
items.
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Clean up your credit
reports
These are the tried-and-true ways to
improve your credit rating.
Don't make any more
late payments. Make sure you pay
every bill on time from here on out. Taking
steps to bring your score up does you no good if
you do things that send it right back down.
Also, the older a late payment is on your credit
report, the less it hurts you. So a late payment
you made last month hurts a lot right now, but
in two years that same late payment won't hurt
your score as much.
Pay outstanding
debts. If you have a delinquent
account, pay it. That won't remove it from your
credit report, but it will still help your
score, because a late payment is not
nearly as bad as an unpaid debt.
Correct
errors. If there are any errors on
your report (such as late payments when you
weren't late), write a letter to the CRA in
question and ask that the error(s) be removed.
The CRA has 30 days to investigate; they'll
write to the creditor and ask them to verify the
payment info. If they don't, the CRA will remove
the negative info from your file.
Make sure negative
info older than 7 years isn't
reported. By law, negative
information in your credit report must be
deleted after seven years (10 years for
bankruptcy). If your report contains negative
info that's more than seven years old, write the
CRA and ask them to remove it. Also note that if
you missed a payment 8 years ago, but it took
the creditor 2 years to report it to a
collection agency, it will show up on your
report as a 6-year-old debt. In that case, write
to the CRA and explain that the debt is really 8
years old and should be removed.
Add your side of the
story. If there is negative info in
your report (such as non-payment of a debt), but
you have a good reason for not paying the debt
(merchandise not received, legitimate dispute
with the merchant who would not negotiate in
good faith, etc.), write to the CRA and ask them
to add your short explanation about the matter
to your file. If the lender pulls your credit
report they might see the statement you added.
They might not see it, because some lenders just
look at the credit score and don't scrutinize
the report itself too closely, but it couldn't
hurt.
Pay down
loans. The more debt you're carrying,
the lower your score. Your debt is evaluated in
comparison to the total credit available to you.
So $1000 of total debt with a $1500 total credit
limit (1000/1500 = 67%) is probably worse than
$3000 of debt with a $10,000 limit (3000/10,000
= 30%). So pay down your debt to increase your
score.
Don't apply for new
credit gratuitously. Applying for new
credit, whether approved or not, lowers your
score. And new approved accounts lower the
average age of your accounts. (Older accounts
score higher.) During your credit-rebuilding
period, don't apply for new credit cards or any
other kind of new loan or credit. Wait until
after your lender has approved you for a
mortgage. The exception to this is if you don't
have much credit history to speak of. In that
case you want to get a credit card to start
building credit.
Get and use a credit
card if you don't have one. If you
don't have a credit card, get one. It will help
you build credit. Just use it to buy your
groceries, and pay it off in full every month.
Here's more on getting a
credit card.
Ignore most other
advice you hear. Myths about what
actually helps or hurts your credit score would
fill a book Some of them are listed at right.
Some of them are even espoused by people whom
you'd think would know better, like mortgage
brokers. But the red items above are all you
really need to focus on. Be skeptical of any
other advice you may hear about how to improve
your score. If it sounds legitimate and you want
to believe it then try to verify it first
somehow, don't just accept it on faith. Because
taking bad advice might not just fail to improve
your score, it could actually hurt it. Really,
just correct errors, get old negative items off
your report, and maintain a good payment
history, and that's pretty much all you need to
do.
Don't pay for
credit-rebuilding services. The tips
in this section are everything you need to
know about rebuilding your credit. There
isn't anything else. Nobody can do anything more
for you than what I've listed above. Don't throw
your money away on credit repair services.
Further
reading
If this page was so fascinating you
could just pee yourself, here are some other
resources you might like.
The Federal Trade Commission covers your
rights regarding your credit report,
Good guides to credit scoring are available
from My
FICO and Mortgage-X.
MyFico also has some interesting credit
statistics.
Speaking about the amount of personal
information that CRA's have about you, Ralph
Nader was the only presidential candidate in
the top three in the 2000 or 2004 elections who
pledged to address this issue. Bush, Kerry, and
Gore don't really care.
Remember, if you take one thing with you
from this page, it's that you need to get all
three of your FICO credit scores before applying
for a loan, and the only place to get them is
MyFico.com.
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This page last
updated in April 2008.
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