It is not necessary to have a great credit score in order to be a successful investor, but it certainly helps. Those with higher credit scores are rewarded with lower rates when borrowing money, for example, among other things.
But consumers with average or low credit scores often don't know what they need to do to improve their scores, and many do nothing as a result.
"Most people don't try to restore their credit, they just wait until it gets cleaned on its own," Joe Crump, real estate investor and author of How to Clean Your Credit in 60 Days, said. "They need to actually do something."
Further, as of last month, the way credit scores are reported is changing: Authorized users will no longer have the credit histories of the accounts for which they're authorized users applied to their scores. Experian began using the new credit scoring system last month, while TransUnion and Equifax will begin using the new system next year.
Using business credit offers some leverage and asset protection
People with limited credit histories on their own, who are taking advantage of the benefits of being an authorized user, could see their scores drop significantly as a result. (For more information on the new credit scoring system, see Credit Boom Turned Credit Bust
Below, then, are the top five tips that can benefit everyone looking to boost their credit score:
1) Using business credit:
This is an option available to active investors or those who are self-employed, though many remain unaware of its availability to them.
Using a line of business credit "allows investors to get credit that doesn't show up on their credit report," Swanberg said. Those interested in pursuing business credit should "shop online or ask their banker," she said.
Consumers can also benefit from keeping balances, if they have any, on their business credit lines rather than their personal ones. Business credit lines do not affect personal credit scores.
One way for consumers to take advantage of business credit is through setting up a company—most likely an LLC or corporation—through which to handle their investments. This strategy offers consumers leverage through business lines of credit and the potential for some asset protection. "With a sole proprietorship or partnership, your personal credit information could be included on your business credit report—and vice-versa," according to Entrepreneur.com.
In addition, "At some point, almost every business needs some type of credit," according to Entrepreneur.com. "To avoid having to use your personal credit history or guarantees and to obtain the best possible terms, start the steps necessary to build a business credit profile…before you really need it."
2) Percentage of credit used:
The ratio of credit used to available credit is a key factor in a credit score. The closer a person is to using all their available credit, the more likely it becomes that they will miss payments. Thus, individuals who keep this percentage lower will generally benefit from higher scores.
The ideal debt to credit ratio is 30 percent or below, Katherine Swanberg, a mortgage consultant who teaches credit repair classes, said. The ratio is not calculated based on total credit available, but credit card by credit card. Thus, a balance of greater than 30 percent on any one credit card can damage a consumer's score.
One way for consumers to improve their debt to credit ratio is for them to call their credit card companies and ask the company to raise their credit limit. Thus, a consumer who regularly charged $1,000 to a credit card with a $2,000 limit could improve their score by getting their credit limit increased to $3,500, because that would change their debt to credit ratio from 50 percent to less than 30 percent.
Balance transfers are another quick way consumers can improve their ratio of credit used to credit available. Because credit ratios are calculated on each individual card, it is better to use 25 percent of the credit available on two cards than it is to use 50 percent of the credit available on one card. Any card with a balance exceeding 30 percent of its limit will have a negative impact on a consumer's credit score. It is once an individual card exceeds 30 percent of its individual limit that the greatest negative effect is realized to one’s credit score.
3) HELOCS vs. home equity loans:
Debt to credit ratios of 30 percent or less can improve credit scores
While high balances of mortgage debt do not reflect negatively on a consumer's credit score, large amounts of revolving debt do. If consumers plan to take loans out against the equity in their homes, they should be cognizant of the different ways in which home equity loans and home equity lines of credit (HELOCs) can impact their credit score.
Because HELOCs operate like lines of credit, with consumers borrowing money and then paying it back, in some cases, creditors classify HELOCs as revolving debt rather than mortgage debt. If a creditor "reports [a HELOC] as revolving debt, it can likely impact your score negatively," Swanberg said.
Home equity loans, on the other hand, are always reported as either mortgage or installment debt.
4) Careful monitoring:
There is more to this than meets the eye. Through the Fair Credit Billing Act (FCBA), consumers are protected against everything from fraudulent charges to charges for goods that were damaged during delivery. The FCBA is what allows consumers to dispute items and errors by sending notice to the creditor in writing.
Once the creditor receives the written notice, they have 90 days to investigate the claim and report their findings to the consumer.
Disputing items "puts the onus on the shoulders of that person who says you have bad credit," Crump said.
Most people also probably think that paying off everything they owe is the best way to improve their credit score. As it turns out, though, that is not always the case.
"Collections that are over two years [old] have very little impact on your current credit score," George Souto, an area sales manager for McCue Mortgage, said. "In fact, it is better to not pay off a collection that is over two years old, because if you do you will bring the last reporting date current again, which will be a recent late payment."
On the other hand, some lenders will not lend to consumers who have any unpaid collections. And, after a certain amount of time, paid collections are better for a consumer's credit score than unpaid collections. Consumers should decide whether or not to pay off unpaid collections based on their individual situations.
Additionally, consumers have at their disposal a tool called rapid rescore. A rapid rescore is when a consumer pays the credit bureaus to rescore their credit report "immediately after giving them proof that something has changed," Swanberg said. "It takes about five days and costs about $30 per issue per tradeline."
Consumers should be aware of how many lines of credit they have open
Rapid rescores are most useful for investors who need to boost their credit scores within a short amount of time. This is a particularly useful tool for investors who frequently buy properties, because they need to have the best scores possible in order to get the best rates available to them.
5) Accounts open:
Another key part of a credit score is the number of lines of credit a consumer has available. While it is better to have too many credit cards than too few, those with too many lines of credit can expect their credit scores to a credit score reduction. Credit scoring takes open lines of credit into account because banks run the risk that, at some point, an individual could charge up to the limit of each of those cards.
While there is no concrete number that is best, many experts, including Swanberg, suggest three to five lines of credit.
"I recommend three to five open [lines of credit]," Swanberg said. It "depends on the borrower and the borrower's score."
If consumers have too many lines of credit open and would like to close one or more lines, they should close the newest lines of credit rather than the oldest, because length of credit history is another factor in a credit score. But for those with only a couple of credit lines more than the recommended three to five, closing accounts might turn out to lower their score. A common rule of thumb is to keep lines of credit that have been active for one year or longer open.