Credit problems have become an epidemic in the United States, and credit repair has become a booming industry. The ease with which credit has been obtainable in the past 20 years, combined with predatory lending practices, have resulted in a situation where millions of Americans now find themselves in serious debt without having a clear path to solvency. It is not necessary, however, to turn to a credit clinic for help. Credit repair can be self-performed by anyone who has patience and discipline and is willing to take action.
The first step is to be aware of your situation. The Fair Credit Reporting Act requires that each of the three major credit bureaus, Experian, Equifax, and Trans-Union, must provide, upon request, a free credit report at least once every 12 months. You can obtain your free credit report online at annualcreditreport.com or you can request it by phone at 1-877-322-8228. Beware scams that pose as offers to provide free credit reports.
You can also request a free credit report if a company takes adverse action against you as a result of information in your credit report. Examples of adverse action are denial of credit or increase of interest rate. The request for a free copy of your credit report must be made within 60 days of notification of the adverse action taken against you.
The second step is to study your credit report closely. Make sure that all the information is accurate and that all the accounts listed are, in fact, yours. It is not uncommon to find an item that belongs to a different person with the same name.
Third, if you do find information that you believe to be inaccurate or in error, dispute it. If you order your credit report online, you can dispute information online. It is preferable, though, to dispute information in writing. That way, you can include copies of any bills, statements, or other documents that support your case. Removal of false information is a critical step in repairing your credit.
The fourth step is to create a monthly budget for your expenses. Credit repair cannot begin until the behavior that caused the credit problems has changed. Your budget must identify all your income and expenses and must set limits for expenditures. You must spend less than you take in. Include a line item for a "credit repair" expense. The value of the "credit repair" item should be as high as you can stand.
As part of your budgeting exercise, call the customer service lines for all your credit cards and finance loans. Ask for a reduced interest rate. Oftentimes, you can receive a lower rate, which will in turn reduce your minimum payment.
In order to prepare a detailed credit repair plan, it is helpful to understand how a credit, or FICO, score is calculated. The details of the FICO score calculation are a closely guarded trade secret. However, there is some information that has been made available to the public. Understanding this information will help formulate an effective plan.
The FICO score is determined based on five criteria:
1. Payment history (35%) Creditors report payment delinquencies of greater than 30 days. The more delinquent, the more adversely the credit scored is affected. Accounts referred to collections are worse than late payments, and bankruptcies are the worst items of all.
2. Amount of credit (30%) There are two primary factors here: the amount of credit available to you and the percentage of available credit you are currently using. Low balances are preferable. Excessive credit lines are not.
3. Length of credit history (15%) The longer you have had a credit history, and the longer you have maintained individual accounts, the better off you are.
4. Mix of credit (10%) This part of the score is a function of what types of credit and how many of each type you have. Installment loans do not hurt you. A few credit cards are OK, but more than four can hurt your score. Finance loans are the least desirable type of credit. A strong score in this area will typically reflect a healthy mix.
5. New credit applications (10%) This section is an assessment of risk due to recent attempts to obtain new credit. The formula does account for shopping for rates, if, for example multiple mortgage lenders process applications in the space of 30 days. Overall, the more recent the inquiries, the lower your score.
Comprehension of these factors is an important step in preparing a credit repair plan of attack for. The biggest benefit is derived simply from paying bills on time. Your credit report tracks 30, 60, and 90 day delinquencies. In order to improve this part of your score, you need to stay "clean". You should not expect to see any improvement in this part of your score before 6 months of on-time payments on all accounts.
The final step in reducing your credit score, and thereby effecting a repair of your credit, is to lower your outstanding balances, particularly for credit cards and finance loans. This step can take time, but it does have an avalanche effect, allowing you to reduce your indebtedness faster as time goes by.
Arrange to make the minimum monthly payments for all your credit cards and finance loans except for the one that charges the highest interest rate. Set up as large a monthly payment to the high-rate account as you can. Include the "credit repair" portion of your budget in this payment. If two or more accounts are tied for the highest interest rate, focus on the smallest balance first.
When the account is paid off, reward yourself. Move 20-25% of that payment into your monthly budget. The rest of the payment should now be applied to the card/loan with the next highest interest rate, in addition to the minimum that you were already paying. When that account is paid off, move on to the next one.
It is not always good to close out a credit card account once it is paid off. If you have five or more credit cards, go ahead and close out the ones with $0 balances. Otherwise, leave them open. Those accounts help you establish credit history and they reduce your percentage of credit utilized.
The credit repair process will likely take years to complete. However, your credit score will be improving the entire time as long as you continue to make payments on time and you don't acquire any new debt.
For more information, refer to the Federal Trade Commission's web site on credit and loans . From the FTC web site, you can find a great deal of helpful information, including information on free credit reports, the Fair Credit Reporting Act, and a booklet entitled "Building a Better Credit Report", a how-to guide on credit repair.