Beef up your credit score in 5 steps

By Liz Pulliam Weston

So you've had a few problems getting the bills paid lately, and you're wondering what you can do to repair the damage.

You've got plenty of company. There are more than 30 million people in the United States with credit blemishes severe enough (score under 620) to make obtaining loans and credit cards with reasonable terms difficult.

Or maybe your credit is OK, but you'd like to make it better. After all, the better your credit, the lower the interest rates you can score on mortgages, car loans and credit cards.

New glimpses into the once-secret process of credit scoring have made it easier than ever to improve your credit -- and reversed some of the advice we personal finance journalists once gave consumers about managing plastic.

(For the uninitiated, credit scores are three-digit numbers increasingly used by lenders when evaluating your creditworthiness. Insurers, employers and landlords also use the scores in evaluating the applications they get. Scores range from 300 to 850. Only about 11% of the surveyed population ranks above 800; 29% ranks between 750 and 799.)

Anyone who wants to improve a credit score should first do some basic housekeeping: Get a free copy of your credit report from one of the three major credit bureaus (click here), scour it for any mistakes and ask the bureau to remove incorrect information. Once that's accomplished, you can start to work on burnishing your score.

Here, then, are the five steps to credit repair:
Pay your bills on time
Payment history is the single most important factor in determining your credit score, making up 35% of the total. Since recent history carries more weight than what happened five years ago, getting in the habit of making on-time payments is an incredibly powerful way to start rebuilding your credit rating.

Likewise, delinquent payments can devastate your score. Missing even one payment can knock 50 to 100 points off a good score. Skipping payments for a single month on all your bills can lower your number from a respectable 707 to the dismal range of 562 to 632, according to the credit score estimator at Bankrate.com. The simulator lets you estimate your credit score and see the impact of various credit behaviors on your score.

Tip: I've found the best way to avoid late payments is to put as many of our bills on automatic as possible. Our mortgage lender, utilities and phone service providers are happy to take their payments directly from our checking account each month. Online bill-payment systems are another way to ease monthly check-writing chore, and many provide reminder services so you don't forget a bill. The latest versions of Quicken and Money have good reminder features, as well.
Pay down your debts -- and consider charging less
Lenders like to see plenty of breathing room between the amount of debt reported on your credit cards and your total credit limits.

The more debt you pay off, the wider that gap and the better your credit score.

What many people don't know is that credit scores don't distinguish between those who carry a balance on their cards and those who don't. So charging less can also improve your score -- even if you pay off your credit cards each month.

Your credit-card issuer takes a look at your account once every month or so and reports the outstanding balance on that day to the credit bureaus. This snapshot doesn't reflect whether you pay off that balance a few days later or whether you carry it from month to month.

Tip: If you plan to apply for a mortgage, car loan or other major credit account in the next year, start paying down those balances now. And if you're in the habit of charging everything in sight to your cards -- to gain more frequent flier miles, say -- consider switching more to cash in the months before you apply. Depending on your situation, the loss of a few miles could be more than made up for by a better score, and thus a lower interest rate.

This kind of advice, by the way, makes the folks in the credit scoring business more than a little nervous. Credit scorers and lenders don't want to see people "artificially" changing their behavior to pump up their scores. Moderation in using plastic is never a bad thing, however, and if the desire for a better score has you using credit more wisely, who's the loser? Oh, other than the fee-charging, interest-rate-boosting credit-card companies, of course.
Don't close old, paid-off accounts
We used to tell people to close accounts they weren't using. Now here's the word from direct from Craig Watts, an executive at Fair Isaac & Co., one of the leading credit scorers: "Closing accounts can never help your score, and often it can hurt."

This knowledge is frustrating to those who want to simplify their lives and reduce the opportunities for identity theft by closing unused accounts. But credit facts are credit facts.

Shutting down credit accounts lowers the total credit available to you and makes any balances you have loom larger in credit score calculations. If you close your oldest accounts, it can actually shorten the length of your reported credit history and make you seem less credit-worthy.

Of course, perhaps you can afford not to care too much about the effect of closing an account. If you don't use your cards much and your score is already high, the damage caused by shutting down more recent unused accounts will be minimal and may be well worth the peace of mind.

If you do carry balances or charge a lot, however, leave all your old accounts open, especially if you're about to apply for new credit.

Tip: Keep all this in mind the next time a department store clerk offers you a 10% discount for signing up for a new card. Each new account can put a small ding on your credit score, and offer a new opportunity for credit thieves. Since closing accounts can hurt, it's better to apply only for credit you really need.
Don't be afraid of credit counseling
If you're overloaded with high-interest debt and are in danger of falling behind on your payments -- or you already have -- consider working with a nonprofit agency such as Consumer Credit Counseling Services to set up a debt repayment plan. These services can negotiate lower interest rates and help you pay off your bills within a few years.

Contrary to what you might have heard, credit counseling probably won't hurt your credit score. It used to, but about three years ago Fair Isaac discovered that people in debt-repayment plans were no more likely to default or go bankrupt than other consumers.

"Today the FICO score ignores any and all references in a credit report to credit counseling or debt management programs," Watts said.

Those references to credit counseling, by the way, are typically removed from a credit report after a consumer has successfully completed a repayment plan. That means there's no lasting reminder on your credit history.

Watts notes that a few lenders still use the old scoring system, which punishes folks on debt repayment plans. Others, particularly mortgage lenders, simply won't work with people in credit counseling until their plans are completed, regardless of their credit scores.

Tip: Don't confuse legitimate, nonprofit credit counseling services with fly-by-night outfits or so-called debt settlement firms. Debt settlement will hurt your credit score, since you're paying less than you owe, and fly-by-night firms can disappear with your payments, making your credit even worse.
Stay out of bankruptcy if you can
Bankruptcy is the nuclear bomb of the credit world -- worse than delinquencies, loans or collections. Its impact, however, depends on how many black marks you made on your credit before you filed.

Bankruptcy can knock 200 points, or more, off the score of someone with otherwise good credit. People with multiple delinquencies or collections on their reports will see less of a decline because their scores are low to begin with. Either way, recovering from a bankruptcy can be tough. Once a score is pushed below 620, which bankruptcy inevitably does, credit becomes scarce and far more expensive.

High-interest lenders love recent bankruptcies, because they know consumers aren't allowed to file again for another six years -- plenty of time to squeeze out lots of high-rate payments.

Mainstream lenders, however, generally will reject consumers with a bankruptcy on their record -- and bankruptcies are reported for up to 10 years.

Knowing your credit score, and the potential impact of a bankruptcy, might help you steel your resolve to pay off your bills and improve your credit situation. Or you may decide you can't make matters much worse, and file anyway.

One last tip: Once you know the impact on your score, get good objective advice before filing for bankruptcy. Attorneys may be overly eager for you to file, while consumer credit counselors may be overly eager that you not. Books such as Robin Leonard's "Money Troubles: Legal Strategies to Cope with Your Debts" offers a more balanced view of the risks and benefits of bankruptcy.