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Summary: Your Credit Score: How to Improve the 3-Digit Number That Shapes Your Financial Future by Liz Weston is the most comprehensive breakdown on credit scores I’ve read in all of the 10 personal finance books I’ve already completed. You can hear our discussion with author and NerdWallet writer Liz Weston covering fixing your credit score and bouncing back from bad credit, how to rebuild your credit history, tips to pay off credit card debt and much more on It’s Time to Raise That Credit Score!

Twenty years ago, you didn’t even have the right to know the numbers that lenders used to judge you. Today, you can get dozens of your scores online within seconds, along with detailed information about what goes into creating each one.” – Your Credit Score: How to Improve the 3-Digit Number That Shapes Your Financial Future by Liz Weston

Today’s review will focus on four areas of your credit score:

  • The Growth of Credit Use (You’re Not Alone)
  • What You Need to Know About Your Credit Score
  • What You Don’t Know Can Still Hurt You
  • How to Rebuild Your Credit Score

The Growth of Credit Use in the U.S.

The first thing you need to know about your credit score is that you don’t have a credit score: You have many, and they change all the time. You also should know that there’s more than one credit-scoring system out there. In fact, currently more than 100 credit-scoring models are marketed to lenders. You’re much more likely to be affected by a FICO (visit MyFICO.com for more info) score than any other type of credit score.”

As we discussed on Why Millennials Are Facing the Scariest Financial Future with author Michael Hobbes, credit, debit, and the usage of both wasn’t as widespread one or two generations before the rise of the Millennials. While it’s true, “By the end of the 1970s, most major lenders used some kind of credit-scoring formulas to decide whether to accept or reject applications” nevertheless, “The amount of credit card debt outstanding rose nearly threefold between 1990 and 2002, from $173 billion to $661 billion.” This explosion in debt and credit use gave rise to the almighty credit score. At least in this instance, we finally know which chicken came before which egg.

The credit-scoring formula is designed to judge how well you handle credit over time. If you have no credit, or you don’t at least occasionally use the credit you have, the formula won’t have enough information to make an assessment. You don’t have to live in debt to get a decent score, but you do need to use credit. … Credit-scoring systems were designed for lenders, not consumers–In other words, scores weren’t created to be easy to understand. The actual formulas and many of the details of how they work are closely guarded trade secrets. … The fact that I could view 19 different scores from one company on a single day helps to illustrate the wide range of numbers that can be used to evaluate bowers.”

Credit scores aren't designed to be fair. They're designed to gauge your risk of default. - @lizweston Click To Tweet

Liz explains that most people can handle their own credit repair. However, if you find yourself in or approaching a credit crisis and you need help from a reliable source, you want a counselor affiliated with the National Foundation for Credit Counseling. Most other service providers are for profit, and as the name implies, they will likely profit off of you rather than provide any helpful service of value that you can actually use to fix your credit. The list of people burned by these organizations is long and ever-expanding, so proceed carefully and do your research. The National Association of Consumer Advocates can provide referrals to attorneys, if needed.

A credit crisis–being unable to manage your debts–can come on slowly as the result of overspending for many years. Many people facing credit and financial problems are hoping for some quick, magical fix. The truth is that there frequently are no easy fixes when you’re in a credit crisis.

Too many people throw half or more of their incomes at a mortgage–a situation that is simply not sustainable in the long run.

The quicker you pick a debt free plan and get started, the sooner your credit can start to recover.

One of the most common mistake people make in a financial crisis is not cutting back hard enough, fast enough.”

“Credit scoring is one of the reasons why consumer credit absolutely exploded in the 1990s. Lenders felt more confident about making loans to wider groups of people because they had a more precise tool for measuring risks.” As a bonus read, you can see the (unattended?) consequences of the U.S. consumer credit explosion and the impact our addiction to debt has had on our households in my review of The Two-Income Trap: Why Middle-Class Parents are Going Broke by Elizabeth Warren. Trigger Warning: It aint pretty.

Smart consumers don't carry credit card balances for any reason, and certainly not to improve their scores. - @LizWeston Click To Tweet

What You Need to Know About Your Credit Score

“When you apply for credit, you authorize the lender to view your credit history. This is known as a “hard inquiry” and can affect your credit score.” Soft inquiries are typically made when lenders simply want to view or pre-approve you for potential offers of credit, like marketing materials. Soft inquiries do not impact your credit score.

Someone who carries a $5,000 credit card balance will pay somewhere around $70/mo in interest. - Your Credit Score: How to Improve the 3-Digit Number That Shapes Your Financial Future by Liz Weston Click To Tweet

If you already have good credit (740+), “Adding a spouse or child to your credit card as an authorized user has long been a good way to boost that person’s credit score because your good history with the account could be imported to their credit file.” Liz recommends prioritizing your debts by how close the balances are to the account’s limits, and then following three basic rules for improving your credit score in the next 30 to 60 days (whatever you do, don’t cash out a 401k or withdraw money from an IRA):

  • Pay bills on time
  • Pay down your debt
  • Don’t open too many new accounts too quickly

We covered more tips on how to rebuild your credit in our interview with CBS News. For instance, Experian’s advice for maintaining a high credit score is based on the following contributing factors:

  • Your payment history (35 percent)
  • Your debt usage ratio: how much you owe in relation to your credit limit (30 percent)
  • How far back your credit history goes (15 percent)
  • New credit (10 percent)
  • Your mix of various types of credit (10 percent)

Because credit history and payment history have such a significant impact of your credit score (totaling 50% in this scenario), it is typically recommended that you never close a card, unless you are concerned about fraudulent use or it has been lost. Liz second this advice, cautioning: “Closing credit cards and other revolving accounts can never help your score, and it might actually hurt it.” Additionally, Liz explains that contrary to some incorrect personal finance advice and opinions on the matter, “closed cards remain on your credit report and continue to influence your score.” Lastly, “the longer it’s been since you opened your first account and your last account, and the longer you’ve been paying on time, the better the effect on your score.”

Most people who use home equity to pay off credit card and other unsecured loans ultimately end up deeper in debt within a few years. That’s because they haven’t changed the fundamental problem of overspending that got them in trouble in the first place. … It’s never a good idea to apply for a bunch of new credit in a short period of time. That’s particularly true when you’re trying to rebuild a score. It’s not a bad idea to wait at least six months between applications for credit.”

What You Don’t Know Can Hurt You

In many cases, positive information may appear indefinitely on your credit report. Federal law only allows negative information, like late payments, collections, or foreclosures, however, to be reflected on your credit report for seven years. Bankruptcies may be reflected for up to 10 years. For a cautionary tale, listen to our interview with Magnify Money’s Mandi Woodruff for how you can avoid accidentally restarting the clock on your outstanding debts and collections. However, just because an account is no longer reflected on your report doesn’t always mean your experience with the lender is over if they choose to continue their pursuit of monies owed.

Credit scores typically predict the change you’ll miss a payment in the new two years. Bankruptcy scores predict the likelihood you’ll stop paying entirely and see to legally erase your debt. Most lenders use both to help assess the risk that you won’t pay. … Normally a payment has to be at least 30 days overdue for a creditor to report it to the bureaus. You’re responsible for paying your bills whether you get a statement or not. You need to keep track of what you ower to whom and make sure that everyone gets paid. Legally you owe a debt until it’s paid, settled, or wiped out in bankruptcy. Your obligation to pay doesn’t end when an unpaid debt falls off your credit report after seven years. The creditor might not be allowed to report the account, but collection efforts can continue.

Recommended Listen: PB84: Automate Your Way to Saving 1x Your Income

Your Credit Score: We Can Rebuild It

There are three major credit bureaus: Experian, TransUnion, and Equifax (Remember the Equifax hacking scandal? Yes, them.) Their business is to manage, collect, and sell your information to lenders. Although all three bureaus use similar models, your score may differ from bureau to bureau, and the same information might not be reflected on each bureau’s credit history profile of you. To simplify what is or is not available, federal law allows you to request your free credit report from each bureau every 12-months at AnnualCreditReport.com. After receiving or reviewing your reports for inaccuracies, keep the following in mind, “If your score is low, however, you should take the negative factors to heart. They can provide a blueprint for fixing your credit and boosting your score.”

If you had an initial FICO score of about 780, for example, you could lose up to 110 points from a single skipped mortgage payment and a whopping 240 points if you filed for bankruptcy. The person who starts with a 680 score can get back to their original score within nine months after a skipped payment, whereas their friend with a 780 score would take about three years of error-free behavior to restore their higher score.”

“The FICO model is set up to place more value on current behavior than on past behavior.” As a positive to you as a consumer, this means you can rebuild your credit history even if you’ve made mistakes in the past. It’s never too late to start, and you will be rewarded for positive payment history and responsible credit management in the present more than you will be punished for poor management in the past with the passage of time. Furthermore, if needed, “credit counseling is treated as a neutral factor, neither helping nor harming your credit score.”

Further, “the bureaus are required by law to investigate any mistakes you bring to their attention and report back to you within 30-days.” Also keep in mind that, “Credit-score models use ‘multivariate’ formulas. That basically means that the value of any given bit of information in your report might depend on other bits of information.”

When it comes to the impact on your credit score itself, “It’s better to have small balances on a few cards than one big balance on a single card. … Your balances (the amount you carry plus the amount you charge) shouldn’t exceed about 30 percent of your total credit limit at any given time.” Further, your overall total balance should never approach your credit limit if you want to maintain a high score. If you’re not sure what, if any, type of cards to open, major credit cards–Visa and MasterCard, American Express, Discover–are typically better for your credit sore than a department store card(s).

If your credit scores are high enough, you’ll qualify for lender’s best rates and terms. Your mailbox will be stuffed with low-rate offers from credit card issuers, and mortgage lenders will fight for your business.”

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