When my fiancé and I first met, I was under the impression that everyone had a perfect Fico Score. Why couldn't they? Your visa statement arrives, you check the amount, write a cheque, and voila! It's paid. The truth is far from this, and I learnt some valuable debt management lessons through my fiancé’s Fico Score.
FICO scores are the credit scores most lenders use to determine your credit risk. There are three FICO scores, one for each of the three credit bureaus – Experian, TransUnion, and Equifax. Each score is based on information the credit bureau keeps on file about you. Your credit scores tend to change as well, as this information changes. We used Fico scores from Equifax.
Six years ago, he had a Fico Score of 534. Today, he has a Fico Score of 721. For people who understand Fico Scores, this is a huge improvement.
Here is how we did it.
A score of 534 indicates a few things, such as a collections item on your report or a complete lack of credit history. In his case, it was a collections item. As a result, banks and other lenders usually do not consider your loan applications, and even if it is considered, you pay a much higher interest rate. When my fiancé was younger, he decided to take out a student loan. Then, he had a car accident and had to withdraw with the course. Usually, people return the student loan to the lender, but for some reason, he felt it was okay to spend the money. So, after awhile, the lender said "well, enough is enough, we have to report you to the credit bureau".
A score of 721 means you have fairly decent credit history, the banks will consider you, and most likely you can qualify for prime. My take on credit scores is this: good credit score saves you money in the long run. And more money in the long run equals early retirement!
It has taken us six years to fix my fiancé’s credit. If someone tells you that there are quick fixes, most likely they are lying. When I researched the net on Fico Scores, many sites said that they are derived from complex mathematical formulae, and more importantly, they are kept secret.
However, what is certain is the following:
35% of your Fico Score is based on: Payment history
30% of your Fico Score is based on : Amount owed
15% of your Fico Score is based on : Length of credit history
10% of your Fico Score is based on: Types of credit used
10% of your Fico Score is based on: New Credit
So the answer is simple. You should always make your payments on time, owed very little on your credit cards and other loans, have both revolving and installment types of loans, and after awhile (actually, a long while), your credit is fixed!
These were the steps we took:
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1) Pay the Collections Item.
There were two key points in dealing with a collections agency. First, I contacted them so that they would cease all communication methods except for the ones I set out for them. This meant that they could not contact my fiancé at his work place, his parents' home, or any other number they may have acquired along the way. All this took was a firm verbal expression over the phone, and letting them know that I understood consumer rights laws. You have every right to ask them to mail or fax the outstanding bill to you before you make any kind of payments; and if you settle the payment close to the end of the month (cut-off time for collectors' commissions), sometimes you can negotiate the interest owed.
On the other hand, if you do not have the lump-sum to settle the collection item, then it's best to send a letter to the collection agency with an initial payment and post dated cheques for the outstanding amount. This shows good faith, and by-law, they have to take it. In reality, for a small amount (in our case, it was $6000), the last thing the collection agency wants to do is to take you to court; but, they are certainly not afraid of threatening you with this. Going to court means larger costs and leaving the matter to judges, and they are not fans of collection agencies.
2. Establish Credit
There are many banks that will issue secured or semi-secured credit cards for consumers with less than fair credit. We went with Capital One, and put down a $75 dollar deposit for a $300 credit card. If you want more credit, you can put down more, but we thought it was best to start with a small amount. We only used this credit card to pay our utility bills, since we would have to pay these bills anyhow. To me, the worst thing to do is to use credit cards for perishable items, such as going out for dinner.
3. Pay on Time Every Time
A blemish on your credit report stays with you for roughly seven years. They count seven years from the time the last activity was reported on your account, and not when the credit was issued. Of course, the impact of a late payment diminishes with time; nevertheless, it is on your report. My fiancé still has the collections item on his report, and it should disappear soon. We made every single payment on time every time. If there happens to be a late payment, it's best that it falls under "30 days late", rather than "60 days late" or "120 days late".
4. Establish an Installment Account
There are two types of credit: installment and revolving. A revolving account is your typical credit card, where if you pay it off, you can spend your credit limit again. An installment account is something like a car loan, where you can a set amount monthly until the loan is completely paid off. Installment accounts are important because they are usually larger loans, and banks like to see that you can handle larger credit responsibilities.
Even with bad credit or no credit, you can purchase a car these days. My fiancé bought a $12000 car with $1000 down and an interest rate of 20%! This is actually very high interest, and the loan was from a second tier bank. Our intention was to pay this interest for 6 months, and then convince a regular bank to take over the loan at a better rate. In hide sight, we should have just gone with a RRSP loan or something smaller.
5. Try Not to Exceed Your Credit Limit
Exceeding your credit limit means you are in need of money....I am sure it can mean a lot of things, but at least that's how most banks view it. Basically, if you can not handle your existing accounts, why ask for more credit? It's just a bad cycle to get into.
6. Time is Key
The minimum amount of time it takes for one to build or rebuild credit is 6 months to 1 year. I think even 1 year is a little bit short. It's possible to pay off the collection items, get a secured credit card, and make timely payments for six months, but this not really long enough to show the lenders that you have changed your ways. We had to be very patient.
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I think there should have been a course in school on credit. At least, parents should educate children on this very important subject. It is something that can cause a lot of damage very quickly, but takes years and years to repair. The key is not to have fear. If you are not going to make a payment, it's best to contact the lenders and let them know your situation. You can also ask them to not report this late payment. Sometimes this works, and sometimes it doesn't. The worst thing to do is to hide from them, and think everything will be okay. Pretty soon, the banks will write off the debt and send the amount to a collections agency. At that time, it's too late. It is best to have good communication with your lenders.
I need to add one last point. Some people think if you have a collections/bad debt item on the credit report, it will disappear after 7 years. Then, they think "well, why don't I wait 7 years, and my credit will be new again".
If you owe to a major bank, it's very likely that they are still reporting your inactivity to the credit bureaus every month. The 7 years is counted from the time when the bad debt was paid in full or the last time the lenders reported activity. Also, let's say that after 7 years, the blemish falls off your report, you will have to explain a 7 year gap to lenders, and they are not that stupid. It's better to take three or four years to pay off your debts and rebuild credit.
