Tips for Credit Restoration

Credit seems to be the buzz-word regarding the economy these days.  Credit is something that affects the biggest banks in the country as well individuals like me and you.  And according to the government a credit crunch and banks unable to lend would be devastating to our economy.  So the macro-economics (big picture) and the politics of credit is confusing, and even irrelevant for those of us who are struggling month to month.

So your credit score is just an intangible number, but it also can have a great effect on your day to day life.  It can effect whether or not you can lease an apartment or get utilities, if you can get a car to drive to work, and other aspects of our day to day lives. 

Chances are, if you are reading an article about credit restoration then you have “bad credit” that you need restored back to good.  The most important part of restoring your credit is to understand what exactly “your credit” is and what “things” effect “your credit”.  I put “things” and “your credit” in quotations because to me they seem to be ambiguous phrases that need to be clarified and explained in order to move forward to financial freedom.

Basically, your credit score is a number (calculated differently by different companies) that is calculated by a mathematical algorithm.  It is important to realize that credit is a numbers game.  It does not factor in the human circumstances; such as job loss, natural disasters, health problems etc., that in reality truly effect a person’s financial situation. 

So, the trick is to put emotions and circumstances aside and evaluate your financial situation objectively and numerically.  If you understand how your credit score and credit is calculated and determined, then you will have leverage in the “system”.

First of all, there is a difference in a credit score and a credit report.  Everyone is entitled to a free credit report every year, but not their credit score.  Go to this website to learn about the differences.  

Secondly, this is a fantastic website that goes into detail about what exactly factors into calculating your credit score.  Visit their website for more details, but I am going to outline the basics of what goes into your score.

1. How you pay your bills (35% of your score).  This refers to how often you pay your bills on time or late.  Additionally, having your account sent to a collections department or agency factors in here.

Tip for restoring credit: pay your bills on time.  Whatever has happened is over with.  Make an effort to pay your bills on time.  If you think you are going to be late, call your creditor to see if you can get a short extension.  Pay a portion of your bill to avoid having it sent to a collection agency.  Do what you can to avoid having your creditor report to the credit bureaus your late payments.

1. Amount of debt you have and the amount of available credit you have (30% of your score).  Having your credit cards maxed out is bad for your credit.  If two people both have $10,000 in debt, but one has maxed out a $10,000 credit card and the other has only charged up half their credit on a card the latter will look better on a credit report.

Tip for restoring credit:  pay down your balances (obviously), but keep credit lines open.  Even after you pay a credit card (and cut up that card if you have to), keep the line of credit open.  Having credit extended to you and not used shows more financially responsibility and less of a financial risk for lenders.

1. Length of credit history (15% of your credit score).  This is both for having credit in general as well as long term relationships with creditors. 

Tip for restoring credit: Same as item 2 – keep cards open even after they are paid off.  Also, if you can avoid payoff plans with credit cards that include your credit line being closed.  Of course, it is more important to get the debt paid off, but avoid closing the credit line if possible.

1. Mix of credit (10% of your credit score).  This means a mix if credit cards and other loans such as car loans and mortgage loans.

Tip for restoring credit:  Department store credit cards can be good for your credit.  If you get an offer when paying for an item that you have the cash for (which is the only time your should be buying right?!), apply for the credit card, get the discount they offer, and pay it off right then and there at the register.   

1. New credit applications (10% of your credit score).  Whenever you apply for credit or anyone reviews your credit score and report, it is marked on your credit report.  The algorithm compensates for rate shopping.  However, it is statistically true that people look for a credit “life-preserver” before defaulting and/or declaring bankruptcy.

Tip for restoring credit:  Do not apply for 20 credit cards at one time.  Apply for one, if you get denied look at your credit report and see why.  It is okay to shop around, but all the companies are looking at the same credit report and score.  If you get denied for the first couple, you will get denied for the rest.

 Here are the factors that do not factor into your credit score:

• age
• race
• sex
• job or length of employment at your job
• income
• education
• marital status
• whether you've been turned down for credit
• length of time at your current address
• whether you own a home or rent
• information not contained in your credit report

Are you surprised that income, age, home ownership etc. do not factor in, because I know I was. However, please note that just because it does not factor into your credit score does not mean specific lenders will not consider these things. That is entirely a whole other issue.

Hopefully, knowing these 5 factors will give you specific action items for your to-do list in restoring your credit.