Credit is the trust granted to you when you buy something that you don’t have the money for, so you borrow it from someone else.  When you borrow it from bank or credit card, that is called buying on credit. Pretty basic. What happens when you go to pay it back is where it gets complicated.

Banks don’t lend money for free, as we discussed in our blog on interest. You must pay it back, plus an extra amount for the privilege of borrowing it (interest). You must also pay it back on their schedule, not yours. Payments can be monthly, quarterly, or yearly. The most common payment schedule is monthly.

When you pay back the money back, the bank reports this to the credit bureaus and you are given a score based on how you adhere to that schedule. It’s kind of like your credit report card. Pay the right amount on time, you get a high score. Pay late or not at all, you get a low score. The higher the overall score, the better you are at paying back your debts.

The banks use this score to determine if you are going to pay back future money you want to borrow, and how much interest to charge you. A high score means they will likely get their money back, so they don’t have to charge as much interest on top of it. A low score means they probably won’t want to lend you money, and if they do, they want to get as much back as quickly as possible in case you decide to stop paying it back, so they charge you a higher interest rate.

Why does this matter? A higher interest rate equals a higher payment, so you want your interest rate as low as possible. Refer to the last post on interest rates, where we outline the difference between two rates and show how much higher your payment each month can be with a slightly higher rate. To make sure you are getting the best possible rate, you want your credit score as high as possible. Scores range from 300-850. Anything above 700 is usually considered very good. The national average score is 687. Anything below 650, and you may want to consider some repair work.

How do you do this? Make sure you pay your bills on time. Pay close attention to due dates and the amount of the payment on credit cards. Pay your medical bills, utility bills, and other miscellaneous bills so they don’t go to collection. Collection accounts become a blight on your credit report and stay there for seven years. They also go right to the top of the report, so the banks will be sure to see them first.

We understand that life gets in the way sometimes, and everyone has missed payments for one reason or another. It is important to try to fix the issue right away, so it doesn’t compound. If you miss a payment, contact the payee right away and determine the best way to fix it so that it doesn’t affect your credit score.

If you didn’t do this, or fell on hard times and had to let things go for a while, all is not lost. There are things you can do to repair your score.

First, order a copy of your report from all three credit bureaus. You can do this for free once a year at www.annualcreditreport.com. Review it for any charged off accounts or other blemishes, like late or missed payments. They are highlighted and at the top of your report, so they will be easy to spot.  Make sure everything listed there is correct, and if not dispute any errors. You can open a dispute online. You will need an explanation of what occurred and any documentation you may have in support of your dispute.

Next, you will want to negotiate any items that cannot be resolved with a dispute. Contact the lender directly and negotiate a settlement in exchange for removing the item from your credit report. If they are unwilling to do this, it will still show as a paid collection account. This is better than a charged off account, because it means you paid the bill, just not on time. Banks look at this more favorably than simply not paying it.

Focus on paying off delinquent (late) or charged off accounts first. Then you can move on to your limits, or, you do not have delinquent accounts, you can start with this step.

Scores are also computed based on how much of your available credit you use. For example, suppose you have a credit card with a $10,000 limit and you have used $9999.99, and you are now asking for more money from the bank for a new purchase. To the bank, this appears like you have a spending problem. This makes you a credit risk and gets you higher interest rates, if you get the loan at all.

Check to make sure your limits are being reported correctly. If they are not, contact the lender and ask them to update the limits on your credit report. If they are and you have high balances, focus on the one with the highest ratio of balance to available credit first. This may not be the one with the highest balance, so go through each one to make sure what you are focusing first on will have the greatest impact. Pay this card below 50%. Then move on to the next highest ratio, and pay that below 50%.  Do not pay each down a little bit each month, as the impact on your score will be negligible. Focus on one card at a time and your impact will be maximized. Once all of your cards are below 50%, go back and do this again to get them below 30%. As you do this exercise, you will see your score start to increase.

If you have a low score because you don’t have much credit, open a new credit card. You may need to deposit a small amount of money with the bank to hold while they extend you credit. This is called a secured card, and is commonly used when a person has little credit or has experienced a bankruptcy. This may feel painful in the beginning, but it only takes a few months for your credit to improve and you will be able to open unsecured cards. Do this as soon as you can, because it will improve your score even more. The caveat is that you need to use your cards, but not too much. Keep those balances below 30% of your limit, otherwise you will see your score start to drop. Do not close one card as you open another, because that will also cause your score to drop. The more credit you have available that you are not using, the better your score will be.

Make sure you pay your bills on time as you do this. Timely payments accounts for 35% of your score, so it doesn’t help you if you are skipping one payment to make another in the hopes of repairing your credit. If you can, pay extra on each card, or pay twice a month. That will reduce your balances and increase your score even faster.

When it comes to credit, there is no fast fix. There are things you can do to improve it, but it will take time. It is much easier to protect a high score than it is to work back from a low score. It can be done, and with a little dedication and perseverance, you can raise your score.

Remember, the sooner you start, the better it will be for you. Order your report today and get started!