Credit scores are powerful indicators of creditworthiness and the likelihood of default, especially when applying for mortgages, credit cards, and auto loans, or when renting real estate and buying insurance. Your score can dramatically affect the cost of credit, because the price and terms you receive are (fortunately or unfortunately) based on this score.
The bad news is that very few of us are taught the discipline of how to use credit correctly.
One of my very best friends, who I met in construction years ago, told me one of the wildest stories about the extremes of credit. My buddy came from Iran, a country that doesn’t have the same type of credit or mortgage systems that we have in the United States. He says that traditionally, most things in Iran are purchased with cash.
My buddy was part of the Shah of Iran’s elite guard when suddenly the regime changed. He was imprisoned and tortured by the Ayatollah’s government. He finally fled to Germany, where he met his future wife, a U.S. citizen. They eventually moved to the States, but a few years later they went through a difficult divorce that forced him into personal bankruptcy.
Since he was my friend, I wanted to help him get back on his feet, especially since his biggest dream (besides becoming a U.S. citizen, which he did) was to buy a home.
Act I: Easy Come, Easy Go
At first, my friend didn’t understand our credit system. After he arrived in America, he couldn’t believe how easy it was to get money from banks and credit card companies. He and his ex-wife were quick to run up lots of debt, not understanding that borrowing can become.
Act II: New Habits
Since he was a friend, I agreed to help him recover from these mistakes, but I insisted that he do everything I said. He agreed. We then proceeded to fix the damage.
Coming off a bankruptcy is about as tough as it gets, next to having a foreclosure, IRS lien, or student loan default; but one thing I know is that time heals all wounds.
In the beginning, I asked him what his system was for paying his bills. He confessed to me that he really didn’t have one. Instead, he paid whomever was screaming loudest.
I explained to him that he needed a system to follow. To get started, I had him bring all of his bills to me. Everything. I wanted to see all expenses, debts, and income.
First, we went through his expenses to see which ones made sense and which didn’t (needs vs. wants). Next, we looked at his debts, and then we categorized them. Some would report to credit, and some wouldn’t. Some could be paid off over time with a payment plan. And, some necessities needed to be paid faithfully and on time.
Of course, we looked at income as well. Since his job was seasonal, we came up with a strategy for income fluctuations, as well as a strategy to pay his bills on time. We also figured out a plan of attack for dealing with his outstanding debt.
It wasn’t long before he even got a secured credit card in place and stopped getting reported for delinquent accounts. As time went on, the negatives on his credit report began to be replaced by positives.
Act III: Building Credit
There are companies out there that can perform credit repair magic. Some may work, and others may be more questionable (for a fee of course).
But the one thing that works every time is paying your bills on time.
I told my buddy that my system entailed filing my bills as they came in by due date. Then on Sunday nights, I’d pay all the upcoming bills for the next week. (Today, of course, I use automatic payments for about 90 percent or more of my bills.) If there were outstanding bills he couldn’t pay in full, he sent partial payments, especially to ones that were fixed, like past medical bills.
Three Years Later…
Now, for the good news. In less than three years, my buddy bought his first owner-occupied house, which had a mortgage payment that was less than his rent. Shortly thereafter, he started purchasing 2-3-bedroom rental properties. Sure, he had to pay a slightly higher interest rate, but he had achieved his dream and still, cash flowed from his two rentals — all after coming out of bankruptcy.
The good news is, if he can do it, so can you.
Knowing When to Protect your Credit
Are there times credit doesn’t matter? Absolutely.
Sometimes you’ll see senior citizens paying in order to protect their credit, and they don’t even need credit anymore. I saw this recently with a close family member of mine.
There are situations where a family should stop paying a debt because their situation is dire, and it’s no longer wise to do so.
But, if you have good credit, and you plan to need it for a while, it is prudent to be vigilant in protecting it. I know I am. Here are few ways that paying more attention can help your credit:
Have your bank alert you of unauthorized use of your credit cards. Check your bills, bank statements, and accounts regularly. Review your budget, income, and expenses periodically.
Also, be pragmatic. Know which bills report to credit and which ones do not. For example, many utilities don’t report to credit (but some do). My cell phone bill does, but my water bill doesn’t; if you have to be late on something, your cell phone is probably one of the worst bills to be late on.
Last, be strategic about your credit. Limit the size of the credit cards in your wallet in case you’re robbed. Keep your identity as safe as possible. Check your credit report yearly. Even I had to have errors corrected. Be careful opening and closing credit accounts, and be aware of the effect doing so will have on your score. And lastly, be aware of your debt-to-income ratio.
The only other way to protect yourself (beyond what’s listed here) is to own less and control more. This has been my number one strategy as of late.
That said, I know I don’t have all the answers. I’m sure there are many more strategies out there. Please share your favorite.
What have you done to improve and protect your credit score?