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Do you have bad credit? If so, you’re not alone. Nearly 1/3 of Americans have credit scores lower than 601, which is considered bad credit.
Just because you’re in good company doesn’t mean it’s ok to stay there. Bad credit has some serious consequences. You might have to pay an additional deposit for an apartment, for example. Or you could actually be completely denied an apartment because of your credit.
And did you know that having bad credit can cost you a fortune?
How Much is Bad Credit Costing You?
Let’s say you’re buying a $20,000 car and need a 4-year auto loan. According to myFICO.com, if you have bad credit, you can probably get a 16.309% interest rate. Your monthly payments would be $570, and you’ll end up paying $7,359 in interest. But if you have a great credit score (over 720), you can get a 4.6% interest rate. This would make your monthly payments just $457, and you’d end up paying just $1,935 in interest.
Bam! You just saved $113/month and $5,424 in interest. Think of the more important things you can do with that money!
And what if you decide to buy a house? Say you decide on a $250,000 house with a standard 30-year fixed-interest-rate mortgage. Scenario 1: You have meh credit (side note: you want at least meh credit to even get a home loan!). Your interest rate would be around 5.565%, your monthly mortgage payment would be $1,430, and you’d end up paying $264,687 in interest. Yikes!
Scenario 2: You have great credit (over 760). Your interest rate would be around 3.976%, your monthly mortgage payment would be just $1,190, and you’d end up paying only $178,429 in interest. You just saved $240/month and $86,258 in interest.
On your car and your house, you’ve saved $91,682 just by having good credit!!! You can’t not be excited about learning how to improve bad credit.
So let’s talk about the 5 proven ways to improve bad credit!
5 Proven Ways to Improve Bad Credit
Now, I can’t promise your credit will improve overnight. It will take a little time to repair. But the important thing is to start now. The last thing you want is to look at your credit next year and think frick, I really should have started repairing my bad credit last year!
1. Dispute any Errors on Your Credit Report
Your credit score could be suffering from a simple mistake on your credit report. So your first step is to pull your credit report and look for errors.
You can get a free copy of your credit report from sites like freecreditreport.com or creditkarma.com.
Now, what errors should you look for?
Here are some of the most common errors that negatively affect your credit score.
- Missing accounts
- Duplicate accounts
- Incorrect payment history
- Incorrect credit limits
- Suspicious activity
If you see a mistake, contact the credit bureau reporting the error and dispute that error. Then give them 30 days to correct the report.
2. Make Payments on All Past-Due Accounts and Pay on Time Going Forward
If you have any accounts with a past-due balance, pay that past-due amount asap.
Now, why was that account past-due?
If you simply forgot to pay the bill on time, you need a better system! Check out our post, Um…Excuse Me, But You’re Paying Your Bills Wrong, for some tips on how to keep this from ever happening again. Late fees and a credit hit are steep prices to pay for forgetfulness.
But if you had to make the conscious decision to pay that account late because there simply wasn’t enough money to cover all your bills, that’s something totally different. Take a look at our post, Help! I Can’t Pay All My Bills to get some short-term Band-Aid tips and some practical steps toward a long-term solution.
It’s imperative that you find a way to pay all your future bills on time. Really, you’ll never be able to get ahead with your quest to improve your bad credit, or your finances in general, if you continue to pay bills late.
3. Pay Down Your Credit Card Balances
One of the factors in determining your credit score is your “credit utilization ratio”. Simply put, this ratio is just the amount of your available credit limit you’re actually using.
Generally, you want your ratio to be under 30%, which would mean you’re using less than 30% of the total credit available to you.
How about an example?
Say you have a credit card with a $5,000 limit. And your current balance on that card is $4,500. Your credit utilization ratio for that card is 90% (4500/5000 = 90%). To get to the desired 30%, you’d need to get that balance down under $1,500 (5000 x .30 = 1500).
So try to pay down your credit balances until they are all under 30% of your credit limit.
4. Don’t Close Your Credit Card Accounts
This might sound crazy at first, but don’t close your credit accounts as you pay off the balances.
Why not?
One of the factors contributing to your credit score is how long your accounts have been active. The older your accounts are, the better.
The credit bureaus average the length of time your accounts have been open and factor that into your score. If you close an old account, the average length of your credit accounts gets shorter, and that has a negative impact on your credit score.
If you’re concerned about your spending, cut up your cards, but keep the accounts open.
There is an exception to this rule. If your card charges an annual fee, and you’re not using the card to collect reward points, close it. You don’t need to pay an annual fee just to keep the account history. Your credit score will rebound as your other accounts age.
5. Attempt to Settle Any Accounts in Collections
Do you have any accounts that went unpaid for so long your creditor turned your account over to collections? Ok, that’s bad. But it’s not the end of the world.
There is something you can do to soften the negative impact.
Contact the creditor (or the collection agency) and let them know you would like to settle. Settling means that you and the creditor will come to an agreement on the amount you’ll pay them back on your account. You may not have enough money to pay back the amount you owe in full. That’s ok. Contact them anyway and let them know what you can pay.
Quite often, they will accept an amount less than the full amount you owe because they don’t want to have to hire lawyers and sue you for the full amount. It’s easier on them and on you to work out a deal so they get some of their money back without a legal hassle.
Now, here’s the magic request: ask if your creditor will agree to a “pay for delete”. A pay for delete means they agree to remove the collections record from your credit history if you pay.
They don’t have to do this. You owe them that money. And they don’t owe you any favors. But it can’t hurt to ask. If they agree to a pay for delete, make sure you get confirmation in writing before paying.
If they don’t agree to the pay for delete, you still want to pay what you can to improve your bad credit. The record of the account having been in collections will remain on your credit report for 7 years. But having the account settled looks much better than an active collections account. And the negative impact will be reduced as that settled account ages, then disappear at the 7-year mark.
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