We are currently in a series of blog posts on the subject of credit scores and the affect they may have when applying for a veteran business loan.
"How Credit Score Affects Getting a Business Loan" touched on the breakdown of both personal FICO credit scores and business credit scores. This article will take that knowledge and use it to show you how to improve your credit score.
Before we move forward, it’s important to disclose that it takes time to improve a credit score. Anything that promises a “quick fix” is just plain wrong. Credit scores, in essence, are a reflection of your payment patterns over time; much like a driving record, problems will not just disappear. Don’t lose heart, though! If you’re patient, over time you will absolutely see improvement. Here’s how:
Get a Baseline Understanding of Your Current Score
The first step in improving your credit score might not be what you’d expect, but is important nonetheless. In order to know how to improve your score, you will want to start by determining what your score is currently and, most importantly, why it is the number that it is. In order to do this, request a copy of your credit report to look it over for errors.
- Check to see if there are any incorrect late payments listed
- Verify all open account balances and ensure the amounts are correct
Are there any errors? A Federal Trade Commission study of the U.S. credit reporting industry found that one in five consumers had an error on at least one of their three credit reports. If you find an error, dispute it with the credit bureau. It may take time for any errors to be processed off of your report, but it will be worth any effort it takes.
Improving Your Score One Section at a Time
Personal FICO credit scores are broken up into several factors. Since each score is categorized, our suggestion to improve your overall credit score is to logically find the sections where you might be weak and begin to make the changes necessary in those particular segments.
The breakdown, by percentages, of your personal credit score is as follows:
- Past Payment History: 35%
- Credit Utilization: 30%
- Length of Credit History: 15%
- Credit Mix: 10%
- New Credit 10%
1. Past Payment History
First let’s look at the category of Past Payment History. As this makes up 35% of your score, the largest portion, you should place significant emphasis here. The basic idea with this area of your score is that every late payment you make is going to cause your credit score to suffer. In order to make improvements, you need to ensure you start paying every single balance on time. This may mean that you create a system of reminders for yourself, such as getting texts or emails from your bank, setting up calendar reminders, or even establishing auto-pay.
In this category, time is the true key to success. Late payments that you made in the past are going to stay on your credit report for a while; as you make new payments on time, slowly those new payments will begin to replace the older late payments. The longer your history reflects on time payments, the more your score will improve. Additionally, old mistakes on your credit report will start to count for less and less as more time passes until they fade off your report entirely. All you need is the patience to let this new payment history rebuild itself.
It’s also worthwhile to realize that there is a distinction between “good debt performance” and “bad debt performance.” Good debt performance examples are ones where your debt has been paid on time and managed responsibly.
The federal law gives you the right to access your credit report from the three consumer credit reporting companies, Equifax, Experian and TransUnion, for free from annualcreditreport.com every 12 months.
If you do have any mistakes or “bad” types of debt performance on your report, it’s important to understand the time frame associated with credit reports: typically, any type of collections or delinquencies on your report will remain for seven years; more serious things, such as bankruptcies or unpaid tax liens, can remain for 10 years. The only reason you can ask to remove an inquiry on your credit report is if it is false or a mistake. Any inquiries on your report will remain for two years.
2. Amount Owed / Credit Utilization
The next category of your credit score is Amount Owed. This section counts for 30% of your score, so it is also substantial and should receive ample attention. The bottom line here is that the more you owe, the lower your score will be; therefore, the best way to improve your score is to reduce your debt or increase your credit limits.
A good strategy here can be to put your efforts into paying off the lines of credit that have the highest interest rates first, while still maintaining the minimum balance on everything else. Once the highest interest credit is paid off, then you can take the money you were using to pay that off, and put it all toward paying the next highest interest credit, etc, until you have minimized your debt (or have paid it off altogether). To reiterate, as you saw with the Past Payment History section, pay everything on time and pay all minimum balances; just try to tackle the highest interest lines of credit with the most gusto at first.
There are also a few myths out there regarding ‘amount owed’ on credit cards and their impact on your credit score that are worth addressing. First, it might or might not be not be in your best interest to move debt from credit card to credit card; instead, try to work toward simply paying off all credit card debt.
If you must have a credit card balance, try to carry the balance on the card with the lowest interest rate.
Credit bureaus look to see how many cards have any type of balance on them. Having a high balance creates a high utilization of the credit card. For example, if your credit limit is $1,000 and your balance is $900 that means you’re at 90% utilization, which negatively impacts your credit score. Therefore, it may be better to distribute the balance and carry $400 on the first card and $500 on another available card.
Another myth is the idea that it’s good to close unused credit cards, but this strategy can definitely backfire. If your credit report shows the same outstanding debt, but fewer open accounts, it can lower you score even more. By the same logic, some think that it can be beneficial to open several credit cards to enlarge their available credit; yet, opening too many accounts in a short period of time can actually lower your score as well. Your best guide here is to avoid overextending yourself and to spread out new card openings. Simply open cards as you need them and ONLY as you need them.
3. Length of Credit History
Length of Credit History makes up 15% of your score. In this section, credit bureaus are looking for your average “account age.” As we just discussed, if you open up too many accounts in a short period of time, that can look risky; therefore, in this category as well, you’re going to see patience truly paying off. Every time you open a new account, it’s going to effect the average length of all your accounts, so the best thing you can do for yourself to improve your score is to only open accounts as necessary.
closing a card from 10 years ago may have negative affect because it shortens the credit length and amount of time you have had credit.
4. Credit Mix
The next category is the Credit Mix, or what types of credit you are taking advantage of, and this makes up 10% of your score. An important thing to note in this section is that opening several different types of accounts is not necessarily going to raise your score, so don’t open new accounts in various places just to make it look like you have variety.
While being negligent with credit cards will hurt your score, being responsible with them can be a huge benefit. As long as you are paying the balances on time and you don’t have too high of balances, using credit cards can actually boost your score. In fact, not having any credit cards might be a red flag to lenders and make you appear riskier compared to someone who has credit cards and uses them appropriately.
It’s also important to note here that just because you close an account does not mean it won’t show up on your report or affect your score.
5. New Credit
The last category, New Credit, accounts for 10% of your score. Knowing about this category might change the way you search for new lines of credit.
Credit bureaus look at hard inquiries rather than soft inquiries. Hard inquiries occur when prospective lenders such as auto or mortgage lenders check your credit report to make a lending decision. Soft inquiries occur when a person or company such as a car or health insurance company checks your credit report as a background check. Soft inquiries don’t affect your credit in any way.
It can be very risky to have multiple inquiries made in a short period of time. Having numerous hard inquiries can lower your score. Try to space out hard inquiries as much as possible.
In some instances, when you’re applying for a business loan, lenders will take into account your FICO score as a personal guarantee, and the higher credit score you have, the better rates you will receive on your loans. As we’ve mentioned throughout this article, improving your score is all about showing positive change over time, so get started on making any necessary changes right away to create an environment that will allow you to get the best possible loan rates for your veteran-owned small business.
Analyzing Your Credit Score
Your personal credit score is very important when applying for a loan. Having a great business credit score is also helpful for lenders. Many of the principles stated in this article also apply to building a great business credit score. It doesn’t matter that the breakdown of business credit score is different than your personal credit score. You can still look at areas where your business score is weakest and take steps toward improvement.
Either way, at StreetShares, we take great care to analyze your score closely to determine your loan amount and loan rates. StreetShares has financing options fit for many business situations, such as the simple term loan, Patriot Express® Line of Credit and government contract financing. Click here to get started with your loan application.