For most people, thinking about their credit–and trying to improve it–usually isn’t a rollicking good time.
But your credit is so important that when you do need it–say, when it’s time to buy a house or a car–you’ll really wish that you had given it some thought.
After all, having a good credit score can save you thousands of dollars.
Your credit report tells the story of your financial history, from how many open and closed credit cards you have to how you’ve repaid your debts. Plus, the information in your credit report boils down to a three-digit number that helps lenders decide whether or not to approve you for a loan or credit card. That’s called your credit score.
If you’ve reviewed the basics, you probably know these things already. But there’s a lot that the basics don’t cover, and questions that you might be embarrassed to ask, like how to start rebuilding your credit after a bankruptcy. We cover ten of the top I’m-too-chagrined-to-ask questions.
1. What can I do to start building credit if I don’t have any credit history?
A great first step is to get a secured credit card. You’re essentially guaranteed approval for a card like this, since it uses a cash security deposit from you as the basis for your credit limit.
Here’s how it works: When you’re approved for a card, you’ll be required to put down a security deposit, usually around $300 to $500. That deposit will then become your credit limit. Secured credit cards report to the credit bureaus, which means that you’ll still be able to build credit–without risking getting too deep into debt. After you’ve proven you’re responsible with a secured credit card, many issuers will transfer it to an unsecured card, and increase your credit limit, which can take a year. Here’s a list of secured credit cards to consider.
2. How does closing a card affect my credit?
It depends. If you only have one credit card, it’s likely a bad move: Closing that card could mean that you won’t have a good mix of credit, which is something that lenders like to see. Also, closing it will deplete your available credit, which isn’t good–having unused, available credit helps your score.
But if you have several credit cards, closing one might not be so bad. It all depends on how high the limit is on the card, and something called the credit card utilization rate–the percent of available credit that you’re using. If your available credit is $10,000, and you’re using $8,000 of it, it could indicate that you rely heavily on credit because you lack cash. It’s best to keep your credit utilization rate below 30%.
As a general rule, the higher your credit utilization rate, the more it might hurt your score to close a card. For instance, if your other cards are maxed out or close to it, closing a card with a high limit could hurt your credit score, because it could boost your credit utilization rate. For example, let’s say that you have $5,000 worth of credit, and you are using $3,000 of it. If you close a credit card with a $1,000 limit, you’ll boost your credit utilization rate from 60% to 75%. So to make certain that closing your card won’t have a severe effect on your credit score, calculate your credit utilization rate without the limit on the card. If it’s below 30%, it’s probably safe to close the card. If not, take some time to pay down your debt first.
3. Will having too many cards hurt my credit?
It’s not the number of credit cards that you have, but how you use them. You could have lots of credit cards and still have great credit—or you could just have one or two and maintain a great credit score. Just remember that the more credit cards you have, the more risk you take on of missing a payment. Your credit will benefit as long as you keep up with your monthly payments, but you still need to be careful not to charge items that you can’t pay off each month–that’s an easy road to credit card debt.
4. Does getting married affect my credit?
Tying the knot doesn’t result in a combined credit report or score. You and your spouse will retain separate credit files. However, as a married couple, you may decide to apply for credit jointly at some point. In this case, your two credit histories will work together to determine your rates in a process called co-signing. So if one spouse has significantly poorer credit, it could put you in a different credit range (i.e. “fair” instead of “good”), and give you higher interest rates. Plus, a loan default will affect both credit reports negatively. But the upside is that both of you will receive credit-building benefits from the new loan once you’re approved.
5. I don’t have any cards. Is there any other way to build my credit?
Aside from starting off with a secured credit card, you can still build credit without cards. Here’s how:
• If you have an installment loan or two, paying those debts will help you build credit. Installment loans include student loans, auto loans, mortgages or personal loans.
• Becoming an authorized user on someone else’s credit card can boost your credit. That person’s good history will typically be factored into your credit. And as long as the individual maintains responsible credit use, your credit will continue to receive benefits.
• Getting a co-signer for a loan will ensure you good rates, and help you to build credit–as long as that co-signer’s credit score gets you approved for the loan. This is only advised if 1.) you were already planning to apply for a loan and 2.) the co-signer is a person you trust. Both of your credit files will be combined for the loan approval and rates.
6. What should I do if a collections agency calls about old debt?
First, you need to verify that the debt is yours. You can do this by sending a debt validation letter, which is a written request for the collections agency to verify your ownership of the debt. There’s a good example of what this type of letter looks like here. The agency will have to do one of two things: 1.) stop attempting to collect the debt or 2.) send verification that the debt is yours.
If it turns out that the debt is indeed yours, work out a way to pay it in full. During this process, negotiate with the collections agency regarding how the account with appear on your credit report after you’ve paid. While most agencies won’t agree to completely remove the account as if it never existed, it’s still worth it to ask. If you settle the debt for less than the amount owed, the collector will probably agree to mark the account “paid – settled” instead. Both of these notations will still negatively affect your credit report, but future lenders will be happier to see that you’ve paid off some debt. Either way, get this agreement in writing before you pay the debt, and find out how long after payment the update to your report will be posted. After you’ve paid your collections debt, be sure to check that all agreements have been fulfilled.
7. Why do employers look at my credit report?
This shouldn’t be a huge concern unless you’re applying for jobs with fiduciary responsibilities. If you’re applying for a position that involves managing a company’s finances, but you’ve had trouble managing your own in the past, employers may think that you’re less suited to the job. Otherwise, your credit report likely shouldn’t be a huge factor in whether or not you get a job. A lot of times, it isn’t checked at all.
8. If I pay off a loan faster than the terms of payment, does that hurt my credit?
It could, but probably not by much. Plus, the benefits of having less debt usually far outweigh the consequence of losing a few points on your score. Here’s a quick run-down of how paying off a loan early can affect your credit:
If you only have one line of credit other than credit cards—like an auto loan, student loan or mortgage–paying it off, and closing the account, will affect your mix of credit. Having a variety of credit (credit cards, auto loans, a mortgage, student loans) is good for your credit because it shows that you can manage different types of debt. Of course, a good credit score is also supposed to save you money. For example, if you have the cash to pay down your auto loan debt, it makes sense to do so early. Otherwise, you’ll just be spending additional money on interest payments.
9. If I co-sign on someone’s loan, how will it impact my credit?
This isn’t a decision to be taken lightly. Co-signing means that you’re using your good credit to get someone else’s loan approved–probably because that person has poor credit or little credit history. Your credit score will be affected by both the positive and negative activity on the loan. You’ll gain the benefit of an extra line of credit without having to worry about making payments, but if the other person misses a payment and defaults, your credit will be dinged. So make sure to weigh the pros and cons thoroughly.
10. I’ve declared bankruptcy. Is there any hope for my credit?
Yes, although it will take some time to rebuild. After a declaration of bankruptcy, a credit score with a “good” rating can drop 150 points. An “excellent” score will take an even bigger hit. You’ll be unable to apply for most types of credit, including credit cards, and you’ll have to wait two to four years to apply for a home loan. When you’re ready to start rebuilding, take it slow by applying for a secured credit card (see #1). After you’ve shown responsible use of a secured card for about a year, try to apply for an unsecured credit card. If you keep making your payments in full and on time, your credit should improve.