Many people worry about what their credit score looks like, especially if they have missed a payment or two, or worse, claimed bankruptcy. The truth is, credit agencies use several factors to determine your credit score. Understanding how credit agencies look at your credit is the first step in figuring out how to maintain or repair healthy credit. You will need to make a firm commitment to taking positive, proactive steps toward managing your debt in order to achieve financial stability.
How Much Debt You Carry
One major component in assessing overall credit fitness is how much debt we carry against how much debt we're allowed. For example: If we qualify for $5,000 on a credit card and our balance stays slightly or far above $2,500 on a regular basis, this reflects very poorly on our credit score. That's why if you currently owe more than you can repay, it will be hard to repair your credit balance without first dealing with the level of debt you owe. Reducing the level of debt to a healthy balance should be your first priority.
What Credit You Use
Next, it's important to understand a few rules about the type of credit you should use to maintain your card balance at a level that will reflect positively on your credit and help you maintain, recover and build a healthy credit score. Here are some tips to ensure you manage your debt in a way that will positively impact your credit:
1) Credit Cards Should Be Treated as Debit Cards
Too often, credit cards are used as loans to be paid back over time. The best way to maintain or build good credit is to regularly pay credit cards off. For example, paying credit cards off every ten days ensures that one never gets too far behind on an allotted balance.
Credit cards can be great if managed like a debit card because they often give rewards points, cash back or travel perks. Another notable point to remember is that when credit cards are paid off, the high average interest rate charged by most credit card companies disappears. This does not take away the annual or maintenance fee for having the card but it does significantly reduce the amount of interest paid towards the card company.
2) Credit History
One major factor credit agencies use in the determination of credit score is credit history. The longer the history of stability, the better the credit score.
Here are a few ideas to build favorable history:
- Open a credit card with a small balance, purchase a small item, pay it off, and keep it open without making further purchases.
- Take out a small personal loan from the local bank, make your payments each month in full and on time, and keep it for the full period. Credit agencies don't usually see prepayment as favorable. Keeping a small loan for the full period will really help build great credit.
- Pay specific attention to medical and cable bills. These often slide under the radar but are generally the quickest to report delinquent status to credit agencies.
3) Good Debt vs. Bad Debt
Debt management is all about balance. There are definitely types of debt that can help in building a solid credit score, and there are also debt situations that can destroy healthy credit. The key is knowing which are which and how to capitalize on the good, without dealing with the bad. Here are a few simple ways to accomplish this:
Regular Credit Card Balance
High Interest Credit
These are just a few examples, but good debt is usually connected with a life need (house, car, education, etc.) and can often carry a favorable interest rate. It is generally a good idea to keep these in play and to pay them on time, every month.
Bad debt is credit that costs a great deal of money to maintain. The primary example of this would be a high interest rate debt. The lower the credit score, the higher the interest rate, because of the high risk a lending agency is taking to loan.
Remember, however, that even good debt, when used excessively, can become bad debt. Don't overextend yourself with too large a car loan or mortgage and make sure you begin to pay off your student loans early.
Having a healthy credit score is a major factor in getting a low interest rate on a loan. This is why it is so important to recover, build or continually maintain a strong credit score.
Here are a few of the many major steps you can take to improve your credit if it is currently below par:
- Pay bills on time every month.
- Keep a credit card with a zero balance open, or pay credit cards off multiple times throughout the month.
- Keep debt payments to a total of half, or less than half, of monthly take home pay. This ensures that you limit your credit to a level that is considered healthy by most lenders.
About the Author:
Douglas Hoyes, Founder & Trustee of Hoyes, Michalos & Associates, B.A., C.A., CIRP, CBV
Doug Hoyes has extensive experience resolving financial issues for Canadian citizens. He is a Chartered Professional Accountant (CPA), Licensed Trustee and Chartered Insolvency and Restructuring Professional and Business Valuator. He regularly comments on a variety of TV, radio and other media outlets on topics surrounding bankruptcy and consumer proposals and writes a column for Huffington Post. Hoyes previously held roles at PricewaterhouseCoopers and KPMG as a CPA. He testified before the Canadian Senate's Banking, Trade and Commerce Committee in 2008. Hoyes has been serving as an OSB (Office of the Superintendent of Bankruptcy) Oral Board Examiner since 2013.