Those suffering financial distress with one credit arrangement tends to see a knock-on effect on other areas of their life. In hindsight, it can often be easy to look back and see how your finances were impacted and what could have been done. However, once your financial situation starts to deteriorate, it is crucial not to look back, focus on now and the future. It is not the end of the world, although it can appear so at the time with debts mounting and demands dropping through your door regularly.
In this article, we will look at ways to improve your credit score when you have bad credit and how you can avoid this going forward.
How is your credit score calculated?
Before we look at ways to improve your credit score, it is worth reminding ourselves of how credit scores are calculated. The first thing to mention is that your credit report is not the same as your credit score.
Financial institutions are committed to reporting missed payments, late payments, and other financial issues by their customers to a central database. Credit agencies and lenders use this information to calculate an individual’s credit score. Thus, over time, it is possible to build up a picture of an individual’s financial management skills, reflected in their credit score.
Whether using scores calculated by the credit agencies or lenders, these are all based on the same information, your credit report. Companies use different criteria to calculate individual credit scores and decide whether the person will be offered finance. How individual lenders use this information will depend upon the type of business they operate. For example, a traditional bank will likely have a higher credit score requirement than a company offering finance to those with bad credit ratings.
In simple terms, a credit score is a reflection of your financial management skills based upon your history.
How can you improve your credit score?
We will now take a look at actions you can take that will positively impact your long-term financial stability. However, it is the cumulative impact of these actions for many people, which can turn around their finances.
Accept what is happening
It may seem strange, but many people fail to accept that their finances are deteriorating until it is too late. Unfortunately, the strategy of “burying your head in the sand” does not work and can make a recoverable situation more complicated. In reality, until you accept there is a problem, how can you even begin to fix it?
Those who fail to accept their deteriorating financial situation will often have options taken out of their control. Once the missed payment fines start falling through the letterbox, this should be a harsh wake-up call.
Face your financial situation head-on
Once you have accepted you are in financial difficulty; it is then a case of listing your debtors, creditors, and any assets you may hold. For many people, this can be a very uncomfortable task, bringing home the reality of where they are today. However, if you are serious about improving your finances and eventually improving your credit score, there is no option.
When you have completed the list, add up your debtors and assets and then deduct your creditors. This will give you a theoretical net financial position – the base from which to start your rebuild.
Monitor your credit report
As we touched on above, the central credit report will list all of your financial difficulties and the companies which added these notes. Even though the Internet has brought credit agencies and credit reports out of the shadows, far few people use these services. You may find that a bad credit score is the result of a misunderstanding or simply human error. This does happen!
You must monitor your credit report regularly and contact specific lenders that have submitted inaccurate information. If you can prove this information is incorrect, the lender in question should adjust this reasonably quickly. This will have an immediate impact on your credit score.
Utilise any savings
If you feel yourself slipping into severe financial trouble and your credit score is taking a nosedive, you should consider using any savings to reduce your overall debt. Some people are concerned about using their savings, their emergency funds if required in the future. But, unfortunately, when you start missing payments and receiving demands from your lenders, the future is here; this is emergency time.
You must bring your finances back under control as soon as possible. Forfeiting savings to reduce your net debt situation will give you a degree of breathing space. It could also save your credit score from falling further.
Utilise any assets
If you have assets that you could liquidate or even downsize your home, this could be a means of addressing your financial issues. At this stage, it is vital to take professional financial advice to discuss the best way forward. This may involve equity release, sale of unused or surplus assets, and even the release of pension lump sum payments.
Avoid multiple credit applications
When you check your eligibility for a credit card or loan, the lender will carry out what is known as a “soft search”. As this is a simple eligibility inquiry, other lenders will not see this on your credit file, although you will be able to. However, when you fill in multiple application forms, the situation can become a little out of control.
When you submit a formal application form for a credit card or loan, the lender will carry out what is known as a “hard search”. This is a more comprehensive look at your credit report before they consider your application. As “hard searches” are visible to other lenders, they can sometimes start to ring alarm bells if you are constantly applying for finance. There is nothing wrong with checking the latest competitive deals in the marketplace but refrain from filling out numerous application forms. It doesn’t look good!
Avoid late payments
We have all been there, struggling to make our income last until the end of the month and putting off one payment until next month. In a perfect world, this should be avoided at all costs. Your payment history is the most critical element of your financial makeup regarding your credit report and credit score. Using the FICO credit score system, there are five different factors to take into consideration:-
- Payment history (35%)
- Credit usage (30%)
- Age of credit accounts (15%)
- Credit mix (10%)
- New credit inquiries (10%)
As we touched on above, once your credit score has started to turn down, it can be challenging to stop overnight. However, the sooner you get a handle on paying your bills on time, the less impact this will have on your credit report and your credit score.
There is a general assumption that lenders will report you to the central database if you miss one payment. This is not the case. It is unlikely that missed payments would be added to your credit report until at least three had been missed in succession. This allows borrowers to address short-term issues without any impact on their credit score.
Consolidate your debts
It is relatively common for an individual to have a personal loan, car loan, credit card, and perhaps an overdraft. If you experience a reduction in your short-term income, this can have a knock-on effect on your monthly repayments and see you falling behind. For many people, the problem is the minimum payments. As there are minimum payments on each line of finance, these can add up over the month. Therefore, it may be an idea to consider a consolidation loan.
This loan would be used to pay off your existing debts. Then, instead of having several minimum payments each month, you would have one minimum amount for your consolidation loan. As a result, many people will see a reduction in their monthly debt-related outgoings. It can also help reduce a heavy mental and physical burden.
Revisit your living expenses
Many of us make the excuse that we “work hard enough to have some enjoyment in life”, which is a fair comment. However, if your finances are struggling and your credit rating is tanking, it is time to revisit your living expenses. You are simply living beyond your means, and eventually, your house of cards will come crashing down. If you find yourself in this situation, it is time to look at your expenditure in minute detail.
For many people, their social budget is sacrosanct, but in reality, it is probably the first element of spending you can cut back. Remember, the quicker you react to your changing financial situation, the faster you will eventually return to some kind of “normality”. There are numerous other expenses to take into account such as:-
Even if you can shave between 10% and 20% from these individual monthly costs, the savings can add up. These savings could then be used to help cover monthly finance repayments and try to get you back on an even keel.
When you access your credit report, you may see reference to “financial associations”. This is a list of individuals with whom you have a “financial link” in the form of joint finance. The most common type of association is a joint mortgage with your partner. It is important to note that just because you share an address with someone does not create an association on your credit report. This is a common misconception!
While difficult to pinpoint the exact impact, if you have a financial association with somebody with a bad credit rating, this could impact your score. Part of the idea behind this is that if they default, then you will likely be left to repay the entire outstanding amount. If you put yourself in the shoes of a lender, does this demonstrate sensible financial management?
Approach lenders if you are struggling
Unfortunately, most of those who suffer financial distress leave it far too late to approach their lenders for help. Consequently, their credit rating will already have suffered before they even start to discuss their problems. If you foresee any financial difficulties on the horizon, speak to your lenders, explain the situation. They may be able to help with a short-term reduction in payments or even a payment holiday. In this situation, it may be possible to avoid any negative entries on your credit report which would impact your credit score.
For those who leave it late in the day to contact their lenders, it isn’t necessarily the end of the world. The majority of lenders would prefer to discuss reorganising your debts, perhaps extending the duration of your loan and reducing monthly payments. This will allow you to get back on your feet, stop missing payments, and slowly but surely, you will see an improvement in your credit score. However, any reorganisation of your finances must be affordable and achievable; otherwise, you will very quickly be back to square one.
Boost your credit history
As your payment/credit history is the most influential element on your overall credit score, there may be ways to use this to your advantage. For example, services such as Experian Boost are proving extremely popular as a means of improving credit scores.
The service involves Experian gaining access to your finances and searching for payment patterns to add to your credit report. These will include utility, phone, and cable payments, and in some cases, monthly rent is used. These are bone fide regular repayments that may not appear on your credit history. However, the previously hidden history of repayments demonstrates a degree of positive financial management. Just what lenders like to see when you apply for finance.
Tackling bad credit ratings
Often, individuals who miss one financial repayment will go on to miss others as their situation continues to deteriorate. As your credit report will have a slight time lag, once your credit score starts to fall, it will likely remain depressed even after you have addressed some of your financial issues. Therefore, if possible, you should address any financial challenges on the horizon before they arrive.
If you have experienced an erosion in your credit score, you can still do many things to retrieve the situation. However, the first thing to realise is that this recovery will not happen overnight; it will take some time. Nevertheless, the realigning of your monthly living expenses, use of assets to reduce net debt, and even consolidation loans can help you get back on your feet.
Many people are tempted to put their heads in the sand once the dark clouds of financial distress start to gather. This is the worst thing you can do. Instead, face your issues head-on, clarify your situation, speak with your lenders and take it from there. A deteriorating credit score can seem like the end of the world, especially if you have dreams of owning your own home, but it can be rectified. There is no need for you to suffer in silence.