It’s one big catch-22: Trying to improve poor credit when you need good credit to improve poor credit. It can make for a confusing cycle that’s as utterly dizzying as it is frustrating.
If you’ve been faced with this never-ending conundrum, you’re not alone; according to Experian, out of 220 million Americans, one in five deals with bad credit. If you belong to this 20 percent of low FICO-scored folk, you’ve undoubtedly asked yourself this simple question: How is a person supposed to improve his credit when it takes good credit to use most of the products and tools that are often recommended to rebuild credit?
Though the answer is not obvious, you can rescue yourself from the bad credit doldrums. There are several options well within reach to put you back on track and improve poor credit.
Credit? What Credit?
What is bad credit? It’s a poor reflection of a person’s financial transaction history that can make it difficult (if not impossible) to obtain a credit card, mortgage or car loan. Lenders and banks are reluctant to loan money to people with poor credit because they are considered high-risk borrowers, with a reputation for not paying their debts back on time.
Simply put, bad credit is usually the result of poor financial choices. Maybe you purchased a home or automobile and became delinquent on your payments; or, as a college student, you fell in over your head with some credit card debt and didn’t pay off your balances in a timely way. Circumstances sometimes dictate the ebb and flow of our financial behavior — even folks who are responsible with their money might incur debt if they’re unable to afford their credit card or car payments after the loss of a job or other circumstance.
Whatever the cause, you might have ruined your own credit without even knowing exactly what credit is. With many of life’s lessons, hindsight is always 20/20, and it’s only after we realize the mistakes we’ve made that we can begin making better decisions for our financial futures.
Credit Scores — A Numbers Game
A credit score is a numerical calculation used to determine the likelihood of someone paying back a loan or borrowed money on time. When your credit card bill is paid on time, in full, it helps to boost your score. Miss a payment (or several), and your score falls, making lenders less likely to loan you money in the future.
Each time money is taken out on a credit basis, lenders report your activity to three national credit bureaus, which use three separate grading criteria to determine a person’s credit health.
- TransUnion: Precision
- Experian: FICO (Fair Isaac Corporation) Advanced Risk Score
- Equifax: Pinnacle
A FICO score is the most commonly referenced credit model and ranges between a scale of 300 and 850 — 300 being the worst, 850 being the best.
From the above chart (courtesy of Buzzle.com), an excellent score is for the elite few with perfect, unblemished credit histories — they will qualify for the best loan interest rates and offers with no complications.
A modest credit score in the mid-600s, which sounds respectable, is still too poor to nail down a low APR on a loan. Choosing between a 10% interest rate, or no loan at all, is like picking the lesser of two evils. A credit score of 500 or below is troubled and might qualify for the worst of loans, if the credit holder isn’t declined outright.
Credit inquiries can hurt your score, too. If you apply for a credit card, the lender or creditor in question will make a standard check on your credit score to see how you qualify. But this will lower your score and poses disadvantages to people with poor credit. You’ve applied for a card to rebuild your credit … but applying in itself damages your credit further.
Loans for Bad Credit
Believe it or not, you might be able to secure a loan with poor credit. The face-to-face approach with an understanding lender can get you closer to obtaining a loan — and closer to improving your credit through traditional means.
Here are three tips to securing a loan despite poor credit:
- Visit a credit union. Independent property managers will sometimes forgo a credit check and lease an apartment based on a potential tenant’s good impression. Credit unions are similar; with an in-person meeting with a credit union representative, the financial institution might be more willing to overlook your credit score; in comparison, local banks might be unable to make these accommodations due to stricter regulations.
- Obtain a peer-to-peer loan. For a person with bad credit, lending from an individual can be a more flexible option than dealing with the standard rules of a bank. This way, things like interest rates and terms of payment can be negotiated on a person-to-person basis.
- Use collateral. You could succeed in receiving a loan by putting up something of value in lieu of having poor credit. Pawn shops loan money if you pledge a piece of jewelry or other valuable as collateral; the item is sold if the loan isn’t paid off by the agreed-upon date. For larger loans, a person cold pledge a car or house as collateral to borrow against. However, this is not recommended due to risk of losing property and other possessions worth much more than the loan value itself.
Credit Cards for Bad Credit
If you have bad credit, chances are that you’ve applied for a credit card and been declined. Another option designed specifically for people with blemished credit is a secured credit card.
A secured credit card requires collateral in the form of a security deposit for a minimal credit limit:
- To help slowly build your credit score, and
- To reduce the risk of going over your credit limit and into debt.
Secured cards require sizable deposits — typically $200 to $500 — which usually becomes your credit limit or translates to a certain credit-limit tier. But watch out! Secured credit cards usually carry high interest rates. Make a late payment and you could not only be penalized at 29 percent interest, but injure your credit history further.
A secured card is like rehabilitation for bad credit, and many financial institutions provide them, including CapitalOne, Wells Fargo and Orchard Bank.
Stand up for Your Credit
You’ve dealt with the drawbacks of bad credit, and now you’re taking the steps to rebuild it. That doesn’t mean you should stop monitoring your credit report and history. Did you know that 79 percent of all credit reports contain errors?
Dispute your credit report with the bank or credit agencies if you feel an omission has been made, or if a recently resolved debt still remains outstanding on your records.
The National Association of State Public Interest Research Groups also reported that 54 percent of all credit reports contain the smallest of typographical errors, which can result in another person’s poor credit ending up on your credit report. Don’t let this mistake prevent you from improving your credit standing.
How to Leverage Good Credit
Congratulations! You’ve made it to the 700s and you’re climbing. Now the last step is to maintain your good credit standing. There are some things you can do to leverage good credit and keep a high score.
- Keep current. Monitor your credit report regularly and check your score and history at least every few months. Cross-reference them with your credit card and bill statements and check for inconsistencies.
- Pay your bills on time. Nothing hurts your credit more than tardiness. Lenders don’t like to wait for their money.
- Aim low. Take advantage of your better credit score and be persistent with car salespeople and mortgage lenders to lock in a low interest rate. It’s a simple correlation: high credit score = low interest.
Think of credit upkeep like a new exercise regimen — a lifelong commitment that needs to be practiced regularly lest we fall out of financial shape. Follow the steps to dig yourself out of a credit conundrum, rebuild your credit and begin again with a strong credit score.
Most of all, be patient. Credit agencies won’t reflect changes to your history immediately, so even if you’ve been keeping up with better spending habits, don’t despair. The payoff in a high credit score is worth more to your financial health than any dollar amount could ever reflect.
Photo credit: Morgan