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If you have no credit or bad credit, you could find it impossible to get financing.
You can say goodbye to your dream of becoming a homeowner.
If you have a low credit score, you’ll be charged a higher interest rate on loans and need to make a higher down payment to buy a home.
According to FHA, down payment requirements rise from 3.5% to 10% if your credit score falls below 580. The upshot is that your credit score is critical. Which is why you need to use these credit hack tactics.
Why Is a Good Credit Score Essential?
There will likely be many times in your life where you require credit. Big purchases such as purchasing a house or apartment, buying a car, or furnishing your home can require a substantial sum of cash.
You may decide that the best way for you to make a purchase like this is to ask for credit from a bank in the form of a loan or mortgage. When you need credit, having a good credit score is crucial and there are some handy credit hacks that can help you bump your score.
Learning about personal finances can help you make changes to your spending, to help you improve your credit score and in turn build your wealth. Those who read and act on the posts and advice you read here on DollarBreak’s pages will break through. Everyday we answer the questions our readers ask and help you tackle your financial hurdles, reduce debt, spend wisely to save money, and create the wealth that leads to long-term financial freedom.
How Does Your Credit Score Affect You?
There are several ways that your credit score can affect you. For example, it could make it more difficult for you to rent an apartment (if you’re finding it hard to rent because of your credit score, read our post ‘How to Get an Apartment with No Credit’).
However, there are two prime ways in which your credit score affects you when you obtain financing:
First, lenders will charge a higher interest rate to those with lower credit scores. For example, let’s suppose you wanted to borrow $200,000 on a fixed rate 30-year mortgage. According to Bankrate, if you have a credit score of 620-639, you will receive an estimated interest rate of 4.997%. However, with a credit score of 760-850, you will have an improved rate of 3.408%.
In dollar terms, the difference in interest payments between the high credit score and the low credit score in this example is $66,754 over the 30-year term of the mortgage.
Similarly, credit card companies will charge higher interest rates to those customers with lower credit scores.
A strong credit score may allow lenders to be lenient with other areas of credit such as the down payment. The average American household has less than $9,000 in their bank, and saving for a high down payment on a house is tough.
If you are having trouble accumulating savings fast for a down payment on a car or house, improving your credit score can give you more power to negotiate this upfront cost.
So, the lower your credit score, the more you’ll be required to pay as a down payment and the less you’ll be able to borrow – plus you’ll be penalized with higher interest rates and higher payments.
How Is Your Credit Score Calculated?
It’s all well and good discussing the benefits of a good credit score, but if you don’t understand what a credit score is or how it is calculated, this information is useless – you won’t know how to improve your credit score.
Around four in 10 Americans have no idea how a credit score is calculated. With this easy guide below, you won’t be one of these.
What affects your credit score?
A credit score system was invented by the Fair Isaac Corporation, also known as FICO. It calculates a person’s creditworthiness by looking at their financial history. Main factors that the FICO considers when calculating your credit score are:
Payment history (35%)
This is the most important element of calculating a credit score and accounts for 35% of the total score. The FICO considers both revolving loans (such as credit cards) and loan instalments like mortgages or student loans.
Balances owed (30%)
If you frequently max out credit cards or get close to your credit limit, the FICO will view you as a person who is not able to handle debt responsibly.
Length of credit history (15%)
If you have a longer credit history, there is more information for the FICO to build your credit score. It is impossible to have a perfect score if you are new to credit. However, it does not take that long to build a good credit history, and once you start taking out credit it is a good idea to hold long-standing accounts.
Credit applications (10%)
New credit applications account for 10% of your total score. When you apply for new credit, it works against you – especially if you apply for several new lines of credit in a short space of time. Only apply for credit as needed, remembering that account balances and length of credit history have a larger overall impact on your credit score.
Credit mix (10%)
The final factor that is considered in your credit score is the variety of credit products you have. This category is a little vague but paying a variety of credits indicates that you are a responsible credit holder and will represent less risk to lenders.
What Does a Good Credit Score Look Like?
Your credit score can look like an arbitrary number if you have nothing to compare it to. In general, credit scores can be looked at in the following way:
- Excellent: 800 to 850
- Very good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
According to ValuePenguin, the average credit score in the USA is 695. You can find out how you measure up by checking your score online – and with a service like Credit Karma, you can check your credit scores anytime, anywhere, freely. That’s right, you don’t have to pay a single cent to learn what your credit score is.
The 10 Credit Check Hacks You Must Use
Here’s a surprising fact: you need credit to build a credit score. Shocking, right?
It’s a strange phenomenon, but if you have never had credit before, you will find it more difficult to get credit now. Without credit, lenders don’t know how you manage your credit and finances – and they see you as a high risk. So, to build your credit score you need to have credit, and then the better you manage your credit the higher your score will rise.
Here are 10 credit hacks to help you build your credit score:
1. Keep Credit Utilization Low
You need to take out credit to build a credit score, but this does not mean you should start maxing out cards. Only utilizing a small amount of the credit available to you indicates to FICO and lenders that you are responsible with credit.
A good rule of thumb is to use only 25% of the credit available to you. For example, if you have a credit card with a $1,000 limit, only use $250 of that credit.
2. Don’t Close Cards
There are some dos and don’ts when it comes to closing credit cards. Keeping a small balance of debit shows healthy credit. You should always keep some credit cards open. While you might consider closing older cards that have high interest rates, remember that long-standing accounts are good for your credit score – so they are worth keeping open even if they do not get a lot of use.
3. Pay off Debt
Payment history and credit utilization account for two-thirds of your credit score. Therefore, the easiest way to build your credit score is to start paying off your debts. Reduce the total amount of debt you own. This will reduce your credit utilization. As you pay off your debts, you will build your credit history.
4. Always Pay Bills on Time
Payment history is the biggest factor in calculating your credit score. One of the simplest things you can do to improve your score is to consistently make your debt payments on time.
5. Reduce Debt to Income
Your debt-to-income ratio is the amount of debt you have in ratio to your total income. The higher the ratio (the more debt you have in comparison to your income), the lower your credit score will be.
To work out your debt-to-income ratio, add together all your monthly debt payments. Then divide this number by your total monthly income (before bills, taxes, etc.).
6. Use Your Credit Accounts Sensibly
Manage your credit accounts sensibly. Don’t borrow money too often and pay your bills on time. Ensure you do this always and you should be able to maintain a good credit score for the long haul.
7. Increase Credit Limits
If your credit card company offers you an increased limit, take it. This way, you reduce your credit utilization without having to pay down. A quick and easy win!
You don’t need to make use of the higher limit, and should continue to manage your money sensibly.
8. Remove Negative Items from Your Credit Report
You may have some black marks on your credit history that are affecting your score and putting off lenders. It is possible that you can contact the credit bureau (such as Experian) and have this removed from your credit history. You will have to make your case and show that you have become more responsible with your credit.
9. Only Apply for New Credit After Carrying out Your Own Credit Check
Every time you apply for new credit, the lender carries out a ‘hard’ credit check. This brings down your score. A single application is unlikely to have a large effect, but multiple applications will.
Before applying for new credit, you should carry out your own ‘soft’ credit check. When you check your own credit score – for example, through a service like Credit Karma – it will be counted as a soft credit check and will not affect your credit score. Credit checks for pre-qualified credit offers are also considered to be soft checks, as are employment verification checks.
Having checked your own credit score, only apply for credit from those institutions who will accept your application based upon your current credit score. This will reduce the number of applications you need to make to get credit, and, therefore, have less effect on your credit score.
10. Get the Best Financial Products
Seek out the best products for your situation. Every lender and type of credit will be different. Some will be more useful to you than others, so to help build your credit and ensure you get the right product it’s essential to do comparisons – and you can do this online.
NerdWallet is one of the most popular online financial sites in the United States, helping users to compare different financial products offered by banks, insurance companies and other financial services companies.
NerdWallet’s reviews and comparisons allow you to do some serious financial research before deciding which credit card to apply for, which loan or mortgage is best for you, which bank account offers you the best rates, and which providers offer the best financial products for your investment cash.
NerdWallet is easy to use and one of its best features is its range of financial calculators – such as its mortgage affordability calculator, which will help you work out how much you can afford to spend on a house. For additional insights, you can also view this home affordability guide. It explains how to quickly estimate your maximum mortgage based on your current salary.
If you set up an account with NerdWallet, you will be notified of your credit score each week – and watch the positive effect of the credit hacks you are using.
Don’t Avoid a Single Credit Hack
Developing a great credit score cannot be done overnight. But these 10 credit hacks will help you to build a better credit score. Stay disciplined, build your score, and benefit from a better financial future.