Subprime credit is a huge and costly problem, but you can fix it.
We tend to think we’re done with grades once we leave school. But there's one grade that follows you around for your entire life: your credit score.
It’s a three-digit number that lenders use to assess your level of financial responsibility. It determines whether you qualify for credit cards and loans and what kind of interest rate you get. Sometimes, landlords, employers, and even cellphone providers use it when deciding whether to work with you.
Your credit score is important. But one in 5 Americans has a subprime score that scares lenders away, according to the latest Consumer Financial Protection Bureau (CFPB) Consumer Credit Card Market study. There's good news, though: You aren’t stuck there forever.
What is a subprime credit score?
What’s considered a "good" or "bad" credit score depends on the scale you’re using. The two most common credit scoring models are the FICO score and the VantageScore. Both use a scale ranging from 300 to 850 with a higher number indicating a greater degree of financial responsibility.
Each lender has its own criteria for which score falls into which tier, but the CFPB study breaks it down like this:
Data source: Consumer Financial Protection Bureau.
Approximately 6% of the U.S. adult population has subprime credit, according to the CFPB study, while 13% have deep subprime credit. These individuals will find it difficult to take out new loans or open new credit cards -- and if they're approved, they’ll pay much higher interest rates than borrowers with near-prime, prime, or superprime credit to account for their increased risk of default.
What determines your credit score?
Your credit score is based on the information in your credit reports. Each credit scoring model weighs these factors differently, but they all look at more or less the same things.
Your payment history is always the most important factor, and a single late payment can drop an excellent FICO score by 100 points or more. Your credit score weighs the number of late payments on your record, how late the payments were, and how recent they were. Each late payment stays on your record for seven years.
Your credit utilization ratio is almost as important as your payment history. This is the ratio between the amount of credit you use and the amount you have available to you. If you have a credit card with a $10,000 limit and you routinely use $2,000 per month, your credit utilization ratio on that card would be 20%. Strive to keep your credit utilization ratio under 30%. A higher ratio indicates a heavy reliance on credit, which worries lenders.
Other factors that influence your credit score include the following:
- The ages of your oldest and newest credit accounts and your average account age.
- The types of credit you have on your account. A mix between installment debt -- debt with a predictable monthly payment, like a car loan or personal loan -- and revolving debt, like credit cards, is best.
- New credit looks at the number of hard credit inquiries on your report. Each one causes your credit score to take a slight hit, but most credit scoring models consider inquiries that take place within 14–30 days as a single inquiry.
How can you improve your credit?
Improving subprime credit is possible, but it takes time. Credit scoring models were designed to provide a long-term view of how you manage your finances, so it’ll take several months or even years to see a significant improvement in your score. It’s worth it, though, because you’ll gain access to better credit cards and interest rates on loans.
Here's how you can do that.
Pay your bills on time
The most important thing you can do is always pay your bills on time.
If you don't qualify for a great credit card, you can get a secured card to start rebuilding your credit. These cards have low credit limits -- typically a few hundred dollars -- equal to a security deposit you make when you open the card. The card issuer reports your monthly payments to the credit bureaus, and full, on-time payments help improve your score. If you close the secured card, the issuer will refund your security deposit, provided you don’t have an outstanding balance.
Keep utilization low
Try to keep your credit utilization ratio as low as possible, but above 0%. If you struggle with this, consider paying your credit card bill twice per month. The card issuer only reports your final balance at the end of the month to the credit bureaus, so paying twice lets you spend more without being penalized for using too much credit.
Don't apply for new credit often
Limit how often you apply for new credit. When you're in the market for a new loan or credit card, submit all of your applications within a few weeks. This minimizes the effect of hard inquiries on your score. If you’re denied, don’t apply again the next month. Wait several months before you try again. The same goes if you’re closing a credit card account. This lowers your average account age, so don't close more than one credit account every six months.
Improving your credit score takes significant changes in how you manage your money. But, over the long haul, it will probably save you money -- and it will certainly save you stress the next time you apply for a credit card, job, apartment, or cell phone plan.
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