68% of American's under the age of 30 make financial decisions that negatively impact their credit score. 30% of American's end up having a credit score under 600 as a result. These numbers aren't pretty and bad credit is no laughing matter. Today we explore what bad credit means for your financial future, how to start rebuilding bad credit, and what credit options might be available to you today if you have bad credit.
Step 1: Know Your Score
First thing is first. You need to know what is on your credit report. You can obtain one free credit report from each of the major credit reporting bureaus each year at AnnualCreditReport.com. This includes Experian, Equifax, and TransUnion. As part of this step, it is important to make sure the information on your report is accurate. If you find any negative marks on your report that are not accurate dispute them. This is the fastest and most effective way to improve your score.
Step 2: Know Where You Stand
Now that you know your score, know what it means. To get the best rates for mortgages, credit cards, and other loans you'll want to be in the Exceptional or Very Good credit category. You'll be able to get approved for most credit offers with good credit. Once you dip into the Fair category you'll start to see some declines for some products and you'll definitely see increased interest rates. If you fall below the 580 mark, you'll have a hard time accessing the best products and your interest rates will be a bit scary.
Let's use credit card debt as an example here. A user with excellent credit might expect to have a credit card with a 12% interest rate, while a fair credit user may expect to have an interest rate closer to 20%. If both users are carrying a $3,000 balance on their credit cards, the fair credit user will pay about $250 more in interest every year. Over a span of 10 years, that sub-par credit is going to cost over $2,500. This same example is going to bleed over into every line of credit the fair credit user needs. Mortgages rates, auto loans, etc. will all be more costly.
Step 3: Understand Your Score
The second step is understanding why your score looks like it does. You can't fix something if you don't understand what is broken. Here are the five categories that impact your credit score.
1) 35% of your score is based on payment history. Having a loan or credit card where you consistently make on time payments is crucial to having a good credit score.
2) 30% of your score is based on the amounts you owe. This is another reason why paying your balance each month is important. Your credit usage should remain below 30% of your available credit to keep your score in good shape. That means if you have a $2,000 credit line, you should aim to carry a balance of less than $600, if you must carry one at all.
3) 15% of your score is based on length of credit history. How long have your accounts been open? This is one reason to open a credit card with no annual fee as early as possible, and to keep it open and active.
4) 10% of your score is based on your mix of accounts. Banks like to see that you have multiple product types, i.e. a mortgage, auto loan, and a credit card. This helps show you are a responsible borrower capable of managing multiple products.
5) The last 10% is based on the number of recent credit inquiries or new credit lines opened. Trying to open multiple lines around the same time will make you look desperate, and as a result more risky.
Step 4: Find a Product to Help Improve Your Credit Profile
If you don't have much of a payment history or if you have missed payments some what recently, you'll want to start to establish a timeline of timely payments. For this, we'd recommend a secured credit card. You'll need to put down a security deposit to open a secured credit card. Your credit limit will be equal to the amount of your deposit. You can normally get started with as little as $250 down. Secured cards will help you show creditors that you are a responsible borrower and your payments will be reported to all 3 credit bureaus. Our favorite secured card is the Discover it.
Why do we love the Discover it Secured Card? Not only is Discover a reputable company, but they have one of the best secured cards in the banking world. Most secured cards will carry an annual fee ranging from $35 - $50 without offering any kind of rewards structure. Discover breaks all the rules with their $0 annual fee card that earns 2% cash back at restaurants or gas stations on up to $1,000 in combined purchases each quarter, and 1% cash back on everything else. Discover will also double all of the cash back you earn in your first year as a thank you for banking with them.
If you don't have any installment accounts on your credit profile or if you don't have the security deposit to open a secured card, we'd recommend a credit builder account. For this, we'd recommend Self Lender.
When you open a credit builder account Self Lender will open a certificate of deposit in your name. You will make a small monthly payment to unlock the cash available in the certificate of deposit. There is a small fee required to open the account and you'll pay interest on the loan each month. Monthly payments start as low as $25 and there is no penalty for paying off your account early.
Self Lender helps your credit score in 4 ways:
- Your monthly payments will be reported to all 3 credit bureaus. On time payments will allow you to build a history of making timely payments. On time payments make up 35% of your total credit score!
- If you don't currently have any open loans, you'll be adding a new type of account to your credit profile. The types of credit you have available to you make up 10% of your credit score.
- Self Lender provides access to your credit score, as well as credit monitoring. You'll be able to monitor your credit score as you go!
- When you complete your loan term, you'll receive a deposit for the amount of your certificate of deposit. You're now ready for the next stage of your credit building plan with cash in hand. You can use your cash for a security deposit on a secured card, or park it in a high yield savings account!
Step 5: Maintain Your Good Habits
Now that you've made a plan and know what you need to fix, stick with it! Maintaining a good credit score isn't hard, but it does take planning. Continue to make your payments on time. Use your credit responsibly. Try not to carry a balance from month to month. If you need to work primarily in cash to avoid the temptation of overspending on your card, do it. Just make sure you are making a small charge on your credit card and paying it off every month so you establish good payment history and habits.