Having a low credit score when you have plenty of income likely comes from poor knowledge or poor choices and can be fixed relatively quickly. After bankruptcy and on a low income, raising your credit score is a herculean effort and not for the faint-hearted!
But it can be done.
No matter what your income, raising your credit score significantly requires patience, perseverance and careful management of how you pay your bills, use credit and build your savings.
The techniques we discuss here will work for someone with no credit - perhaps a college student, someone who recently declared bankruptcy or anyone who has a credit score around 600 or less.
Struggling to make ends meet but still managing credit
Living in the San Francisco Bay Area is expensive. (So is New York, Honolulu, Boston, Washington DC - the list is growing.) If you earn an IT or Engineers wage, paying for your lifestyle isn’t a big issue. But what about those who work minimum wage jobs or have incomes under the median household income of $96,000. Managing credit on low incomes is difficult and requires a clear strategy matched with a few credit score hacks.
The first step in any debt payment plan is to reduce expenses, but it is not uncommon in this area to have your rent be 80% of income. Even with the aid of food stamps and food banks, the only answer is to boost your income or lower your cost of housing by sharing spaces. In an area that favors high paying jobs to those with college degrees, that can be a challenge for people relying on their labor to earn income. Regular, full-time roles in low skilled occupations are extremely competitive.
Building your Credit Score After Bankruptcy
Some time ago, I met a woman, let’s call her Jane, living in Silicon Valley on $20,000 with two young children. My family struggled to get by on $65,000, and I wanted to know how she managed.
Life was difficult; Jane had discovered the negative aspects of credit the moment she separated from her husband. With two young children and a part-time job working at Costco, she found herself reliant on credit just to keep a roof over their heads. Being legally married, she discovered she was also liable for the debt her husband was accruing. The best advice she received was to start over. She obtained a divorce with help using free legal services for low-income people and also declared bankruptcy. Now was her time for a do-over. Her credit score was 220.
Jane had ambitions but zero support.
Without immediate family to rely on regularly, she needed to find a way to manage independently in a high cost of living location. She also knew that it would be very difficult to grow herself beyond her current situation if she didn't have a good credit score.
Boost your Debt to Income Ratio
Given that Jane could not raise her regular paycheck, she used her networking skills to pick up casual work. Talking to friends, colleagues and even regular customers at the supermarket helped her pick up an amazing amount of odd jobs to boost her income to guarantee she could pay her essential bills.
The array of jobs Jane took on were vast:
- Demolishing a kitchen - clean up and labor help for the contractor
- Companion care for an elderly lady who’s family needed a trustworthy and kind-hearted person to spend time with her, make her a cup of tea, or shop for groceries with her
- House cleaning - just 2 houses a week were enough to help
- Before and After school care for children at the nearby local school
- Homework help and tutoring students who were learning her native language
- Pet sitting
Jane realized that the more casual conversations she had with people, the more she offered her help. She also bartered for services that saved other people’s time and effort requiring zero cash from her - cleaning her dentist’s office each week to pay off braces, managing a sports team so that her talented, athletic child could play on an expensive Club Team, shopping for paper supplies for an exercise studio in exchange for free classes, and more. She got creative!
As she earned more money and paid her bills, her credit score began to rise too, and she began to notice what worked and what didn’t.
How Long Does Raising your Credit Score Take?
Jane managed to take her credit score from a low 220 to 723 in about ten years.
She says her key was paying bills on time by earning as much extra income as possible and never exceeding a 20% debt to the available credit base. She recently tried the double payment on her credit cards and noticed the extra bump very quickly. In her words, “life was tough for a while, but now, life is good.”
These are the tactics Jane learned recovering from bankruptcy, and I also used to go from a credit score of 0 to 800 in 12 years.
What Makes Up a Credit Score and Why Should you Care
A credit score or ranking is created from your financial history and predicts your likelihood of default. A higher number means you are less likely to skip a payment or to not pay your bills. If someone is to do business with you, they want to know how risky that will be for them.
Who uses credit scores?
Landlords, anyone offering you credit or pay later situations - stores, gas stations, utility companies and of course, banks for personal or home loans. There are even rumors of certain jobs requiring your credit scores. Our economy runs on record of payments, the level of financial risk you bring to a business.
To offset someone with a high level of financial risk, indicated by a low credit score, lenders may require something extra to lower their risk. This may be a higher interest rate on a car loan, a higher down payment on a purchase or rental deposit or even a guarantor or co-signer when you do business.
Low-income earners need to carefully manage their credit scores to avoid the extra costs- interest rates or high deposits - associated with a lower credit score.
No Credit History - Where to Start
When I first emigrated to the United States, we had a credit score of zero.
I quickly learned what this meant in the Chevrolet car sales parking lot as we navigated a new car purchase! I had always been slightly terrified of credit cards and generally avoided using them, paying in cash instead - that is not a strategy that works well for your credit score.
Starting from zero - whether a college student or a new immigrant, you need to develop payment history in your name.
- Establish a bank account in your name that is not connected to a guarantor. High school students can do this as soon as they turn 18 years old. You would lose your old account number if you had a high school checking account attached to your parents’ account. Remember to change any direct deposits, such as your paycheck, to the new account! This will help with the length of your credit history, even if you have no plans for big purchases.
- Set up utility accounts in your name - utilities, phone, cable and internet. Some providers will ask you for a security deposit if you do not have a credit card. You can usually ask for this to be returned once you either have a credit card or establish a pattern of on time payments.
- Record your income with the IRS. A regular paycheck from your employer will include taxes and be recorded, but what about the extra income you rely on? Sidestepping the IRS does not help your credit score! If you work for yourself and the amount is significant, it may be time to set up a business and put yourself on the payroll.
- Apply for a secured credit card. A secured credit card is one where you give the bank something of value and they let you borrow against the value of that item. Generally speaking, this will be a cash deposit. You can put forward a deposit as low as $50 to open your first card and as you establish a record of payment, you will be able to increase the amount of credit you can use. Beware though - the interest rates are high on these cards!
You may hear advice to take out a small personal loan to help you increase your credit score. For example, securing a personal loan of $5,000 with a guarantor and then pay it off early.
For some people, this takes the form of a car loan, and while that will certainly add to your record of on-time payments, this was not necessary in my experience. A new credit card will help you begin building credit.
Paying your Bills on Time
Pay the bills that report to the credit bureau first. Typically your phone bill and some utilities don't factor this in - although if you want to include these bills to help raise your score because you pay on time, Experian has an Experian Boost program that you can sign up for - for free, to capture those payments. Any payments to a bank will be on your credit report - credit cards and loans. Be sure to pay those first.
When paying bills individually be sure to pay before the due date. This avoids a lost check scenario or transfer delays. The penalty fees of a late payment and the ding to your credit score are not worth the risk of waiting until the final day.
If you struggle to keep track of all your bills and the different due dates, try enrolling in autopay programs. Have the bill charged to your credit card each month, and then you have one bill to pay each month and the other bills will all be on time.
Managing your Credit Card to Boost your Credit Score
Using your credit card is a buyer beware scenario.
Always maintain a healthy fear of carrying a balance on your credit card because the interest rates are high - 14 - 24% in most cases. Personal loans tend to be 6% - 16%. If you run into trouble with your credit card balance, it may be worth taking out a personal loan to pay the credit card bill -and stop using your credit card until the loan is paid off. This will save you fees and also save your credit score from declining further.
Use your credit card to really boost your credit score:
- Make payments twice a month (split the full amount into two) before the due date can really help your credit score. On your credit report these payments register as two on-time payments rather than a single bill payment with your credit card company. This tactic boosted Jane’s score from 600 to 720 fast!
- Get in the habit of not carrying a balance on your credit card. When you receive a statement, look for the Account Balance - this is the amount to pay, not the Minimum Due. The Minimum Due is just to pay the interest and will not help raise your credit score. Your goal is to have zero debt at the end of each month to show that you can reliably manage debt. Missed payments can really ding you.
- Every 6 - 12 months apply to have your credit limit raised on your credit card. This helps with your ‘available credit.’ Your credit score calculates, in part, how much of your available credit you are using. Your income is $20,000 per year and you have a credit card limit of $10,000 in an oversimplified way, you have essentially $30,000 available to you each year. If you use 20% of that credit utilization amount ($6,000), you are considered living within your means and low risk. If you have a credit card limit of $200, you only have $20,200 available. A credit limit increase is a great way to boost your credit score fast as long as you don't overspend and still pay your bills on time.
Managing your Risk
The goal in managing risk is to keep your debt to income at a level where you can, theoretically, pay off your debt. Credit agencies establish that acceptable risk as not being more than 20% of your income.
If you earn $20,000 per year you do not want to have more than $4,000 in debt at any given time. When you demonstrate that you can manage debt and are not living beyond your ability to repay debt your credit score will improve.
Whenever you apply for credit, or someone looks at your credit score, you lose points. If you apply for multiple lines of credit this can look like you are running into trouble and your credit score will plummet.
For example, if you were to buy a car, rent a new apartment, apply for two credit cards and apply for a store credit card your credit score will drop even if you won’t use any of it! When starting your credit life do it gradually - every 6 to 12 months should manage the credit score impact.
Finally, avoid closing accounts that have lines of credit even if you have paid the debt off or no longer use the credit card. With a car loan you just make the final payment and with credit cards just don’t use them. This helps increase your available credit rate.
Managing credit card debt and knowing how to increase your credit score is not something we are generally taught in school. It tends to be life that teaches us! Knowing what will and won’t affect your credit score is helpful for those venturing into independence but also for anyone with the ambition of one day owning your own home and taking on a mortgage.
The more informed you are about credit scores, the higher your credit score will be and the less you will pay in interest and penalties.
And suppose you are ever curious about how your credit score is doing. In that case, you can use free credit report tools like Equifax, Transunion, Annual Credit Report or Experian to get a look at your current or new credit score.
The bottom line is to control your personal finances; whether you are working on building credit or credit repair, it is manageable with the right steps!
You might also be interested in: The 5 Best Credit Cards for People with Bad Credit