Cleaning Up Your Credit

published 31 January 2009

With all the financial upheaval over the past year, including the subprime-mortgage mess and the rescue plan for banks toppled by risky loans, it wouldn't be surprising if you were tempted to think that credit is a four-letter word.

But one important lesson this crisis has driven home is that your credit is the financial equivalent of your good name. A good score is your ticket to a home, a car, a credit card or even an insurance policy, and even a tiny slip-up can come back to haunt you. That's especially true now because the credit crunch has spread to other types of borrowing. For instance, banks have been forced to write off record levels of credit-card debt, so they're setting the bar higher for potential borrowers. A year ago, a score of 720 would have had lenders lining up for your business. Today, a score of 740 or 750 will get you an account but might not qualify you for the lowest interest rates, says Bill Hardekopf, of LowCards.com.

If you haven't already done so, start by taking a look at your credit report. Log on to AnnualCredit-Report.com and get a free copy from each of the three credit bureaus: Equifax, Experian and TransUnion. (Note: Copycat sites often require you to purchase other services in order to get a "free" credit report.)

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While you're on a bureau's Web site, you'll also have the option of buying your credit score for $6 to $8. If you've already used your once-a-year free pass on AnnualCreditReport.com, go to myFICO.com to download your reports and scores ($15.95 for the score from one credit bureau, or $47.85 for all three).

Go through your report with a fine-tooth comb and file a dispute immediately with each bureau that reports an error. The process isn't lightning-fast (you typically have to wait 30 to 45 days for the bureau to investigate any disputes you submit), but be persistent until the problems have been resolved. Big issues, such as an incorrect notation that an account has gone to collection or a home is in foreclosure, could cost you 100 points or more on your credit score.

Gerri Detweiler, credit adviser for Credit.com, says it's also important to check the dates on any negative information that's being reported. Negative items, such as collections accounts, may generally be reported for seven years from when you first fell behind. Two exceptions are bankruptcies, which may be reported for ten years, and tax liens, which may stay on your record indefinitely until you pay them.

Other things to watch out for: paid-in-full accounts that still show a balance and someone else's record that appears in your file. If the credit bureau misspells your name or reports your address incorrectly, that won't affect your score. Balancing act. It's important to minimize the ratio of your outstanding debt to your credit limit (what's known as your credit-utilization ratio) for each card you hold. If you're near your limits and a long-standing customer with a good history, you could ask your current card issuers to raise your limits. Or you can focus on paying down your balances so that you're using less of your available credit. A good rule of thumb is to aim to keep your balance below 30% of your limit on each card.

If you're concerned that a recently frozen home-equity line of credit will tip the utilization scales, don't worry. Ethan Dornhelm, of Fair Isaac, the company that compiles the FICO score, says the scoring model excludes HELOCs from such calculations.

And don't apply for new credit cards you don't need. That 10% discount a retailer offers when you sign up for its card isn't worth it. When you apply for new credit, an inquiry is made on your credit report. Each inquiry is a tiny ding, but enough dings can add up to a dent, especially if your credit history is short. Craig Watts, of Fair Isaac, says that your best bet is to take on new credit only when you need it.

Pay your bill in full each month if you can. If you can't, pay at least the minimum, and make your payments on time. Late payments lower your credit score and may automatically trigger a higher rate. And if other lenders see that, they may raise your rate, too. That could result in more late payments in the future-and thus set off a vicious cycle of credit-card debt.

If your payment date is inconvenient, call your card issuer and request a change in the date. It may take a cycle or two to get results, but lenders are often happy to work with you.

Anderson has been with Kiplinger since January 2004, when she joined the staff as a reporter. Since then, she's covered the gamut of personal finance issues—from mortgages and credit to spending wisely—and she heads up Kiplinger's annual automotive rankings. She holds a BA in journalism and mass communication from the University of North Carolina at Chapel Hill. She was the 2012 president of the Washington Automotive Press Association and serves on its board of directors. In 2014, she was selected for the North American Car and Truck Of the Year jury. The awards, presented at the Detroit Auto Show, have come to be regarded as the most prestigious of their kind in the U.S. because they involve no commercial tie-ins. The jury is composed of nationally recognized journalists from across the U.S. and Canada, who are selected on the basis of audience reach, experience, expertise, product knowledge, and reputation in the automotive community.