Getting a loan soon? In today’s guest post, Certified Financial Adviser Joseph Hogue shares some ways to boost your credit score before you apply for a loan.
The original title of this article was going to be, “3 Tricks to Boost Your Credit Score…,” but then I thought better about giving the impression that your credit score and lenders were something to be tricked into giving you a better interest rate. Like most things in life, there is no quick-and-easy solution to improving your credit score but with a little work and these three tips, you can save yourself thousands in interest over the life of a loan.
The graphic below shows the five credit score factors used by credit bureaus to determine your credit score and on which is based the interest rate you pay on loans. Using ways to manage each one of these will go a long way to boost your credit score and save big money.
The first step most people take to boost their credit score is by reviewing their credit report for any errors. Your credit score, based on the information in a report from one of the three credit bureaus, is the single most important determinant to the interest rate you pay on a loan.
What most people do not know is that the Federal Trade Commission (FTC) found that at least 5% of credit reports contained an error in the person’s payment history. Since payment history is the biggest contributor to your score, an error can cost you dearly. Missed payments, defaults and even worse errors cost the average person 25 points on their credit score.
Fortunately, the Fair and Accurate Credit Transactions Act (FACTA) gives you the right to see your credit report free each year and argue against any errors. If you find any errors on your credit report, you can write to the business that reported the problem. If they do not reply back to you within 30 days then you can write to the credit bureau at which the report is filed and they will remove the inaccuracy. Sometimes, if the business sees their error, they will help you contact the credit bureau and remove it.
Throw a debt snowball
Not only is the amount of credit you have outstanding important to your score but the number of opened accounts can also bring your credit score down and increase loan rates. While paying off high-interest credit will save you money over time, I like to use another method I call the debt snowball to make a big change to my score.
Arrange all your debts and credit accounts in a list from the lowest amount owed up to the largest. After looking over your budget and figuring out how much you can use each month to pay down debt, you will use this list to allocate your payments. While you’ll still need to make the minimum payment on all debt, put more money to the smaller accounts.
It feels great to watch those credit accounts fall off your list as each gets paid and closing accounts from your credit report can help to increase your score. You won’t want to close all accounts because you still want to show a responsible use of credit but closing some accounts lets lenders know that you are not reaching for credit anywhere you can find it.
Again, this is contrary to what you’ve probably heard about arranging your debt by interest rate and paying the higher rates off first. While that makes sense over the long-run and saves money in interest, closing those smaller accounts can really help improve your credit score.
Consider consolidating your debt with a peer loan
It took peer lending site Prosper more than eight years to originate its first $1 billion in loans. The second-largest peer lender originated its second $1 billion in loans over just six months earlier this year. Demand for online loans is surging as an investment and as a way for borrowers to get the money they need.
Peer loans are better for your credit because they are classified as installment loans rather than revolving loans, the classification for credit cards. Installment loans, like a mortgage or auto loans have a fixed period in which they are paid. Revolving loans drive your credit score lower because they have open-ended terms, allowing you to continuously run up more debt.
Rates on peer loans are as low as 6.7% for those with good credit but even higher-risk borrowers can get a loan of up to $35,000 to consolidate their debt at a rate of 15% or lower. There are risks to peer lending but they can be limited by using a little financial common sense.
Since getting a peer loan is a loan in itself, I recommend you spend a couple of month’s working on the first two tips above. Fixing any errors on your credit report and paying off smaller debt accounts will take a few months to accomplish any meaningful difference in your credit score.
Just a small improvement in your credit score could mean big savings on a loan. The average credit score differs across the credit-risk ratings for Prosper loans by an average of 24 points while the average rate across categories differs by 3.7 percent. That means improving your score enough to get in the next higher category could save you almost 4% on a loan or a savings of $1,078 on a five-year loan for $10,000. Even if you decide not to get a peer loan, increasing your credit score from the first two tips will help you lower your rate on traditional loans.
Editor’s Questions: What steps have you taken to boost your credit score? Have you ever discovered a mistake on your credit report? What’s your take on peer lending?
About the author: Joseph Hogue (CFA) blogs at peerloansonline.com. Peerloansonline.com is your first stop into the world of peer lending. Whether a borrower or an investor, you’ll find everything you need to make your experience a success.