10 Steps To Improve Your Credit Score
If you were raised with conventional wisdom surrounding money, you probably just balked at the sentence I just wrote. How could the economy reward people in debt?
Isn’t debt evil?
The short answer is no.
The long answer is it depends.
The key is to understand that there are two kinds of debt: good debt and bad debt.
Bad debt is used to purchase liabilities that do not provide cash flow. These are things like cars, vacations, personal homes, etc.
Good debt is used to purchase assets that put more money in your pocket each month than the cost of the debt takes out. These are things like investment properties, capital investments in your business, investments in product development, etc.
One of the keys to the Rich Dad philosophy is understanding debt and using good debt to get rich.
Bad debt, of course, should be avoided, as any financial advisor would say. And if you have bad debt, you should pay it off quickly, but good debt is something you should embrace. The reason for this is simple, you can accelerate your return on investment (ROI) by using debt, aka Other People’s Money (OPM), to purchase assets. This is because you have less of your own money in an investment, but you still enjoy the cash flow from that asset.
Importance of Good Credit
The key to using good debt to get rich is having good credit. This is a foundation of any personal finance philosophy and is for us too. Simply put, the higher your credit score, the easier it is to get debt, better terms on that debt, and insurance to protect your investments.
Credit is scored on a scale between 300-850, and there are four major credit agencies that calculate your credit score. A score above 700 is considered good and anything above 800 is excellent.
According to Equifax, here are the factors considered in credit scoring calculations. Depending on the scoring model used, the weight each factor carries as far as impacting a credit score may vary.
- The number of accounts you have
- The types of accounts
- Your used credit vs. your available credit
- The length of your credit history
- Your payment history
The easiest way to improve your credit score is to reduce your bad debt and to pay your creditors on time (or negotiate with them for extensions as you pay yourself first).
This takes emotional intelligence, as I mentioned before. If you have emotional intelligence, you’ll be able to say no to impulse buys for liabilities that will ultimately hurt your credit score. If not, well, you’ll probably never get rich.
Freedom from Debt You Don’t Want
Kim and I had a lot of debt when we started our lives together. We estimate we had a total debt of about $400,000 and growing, as interest accrued. Much of this debt came from a business I lost early on in my career. On top of that burden, we went through a horrific year in 1985 as we were building our next business. It is hard enough building a business when there is not much money coming in, but it was even harder with $400,000 of debt hanging around our necks. It was not a fun way to start a life together.
As those of you who have fallen behind know, it is hard to get ahead with debt hanging over your head. It was tough just buying a car, which we did at an extremely high-interest rate. During this period of our lives, we worked odd jobs just to cover our debts, to eat, and to keep a roof over our heads. We did this after we worked on our business. So, we know well what it’s like to be swimming in debt. We know what it’s like to struggle financially as well as endure the stress and anguish it causes.
10 Steps Kim and I Followed To Get Rid of Debt
- Tell Yourself the Truth
The first, and probably the toughest step of all was to commit to telling ourselves the truth—to face the grim reality of how much we owed and to whom we owed it. We knew we could easily lie to ourselves and pretend we were okay financially, which is what many people do. So, face the hard facts and hold yourselves accountable.
- Stop Accumulating Bad Debt
There’s a saying that goes, “When you find you’ve dug yourself into a hole… stop digging.” We basically put a freeze on all debt. Anything we purchased was paid off that month. We stopped adding to our existing credit card balances and took on no new loans. That step alone forced us to be much more cognizant of what monies were flowing out.
- Make a List of All the Debt You Owe
Write down every single debt you owe. This may include credit cards, school loans, car loans, boat loans, IOU’s to individuals such as friends and family members, store credit accounts, vacation home, and your personal residence. Do not include debt for investments, such as rental properties and business investments. And just a reminder, your home is not considered an investment.
- Hire a Bookkeeper
We hired a bookkeeper. She became a valuable member of our team. People often ask, “Why hire a bookkeeper when you have little-to-no money?” The answer is simple: Because our bookkeeper forces us to face the truth of where we are financially every single month.
- Make a Visual Picture of Each Debt
From the list you’ve made in Step #3, create a visual drawing of each debt. Draw a blank CASHFLOW Quadrant. In the upper left-hand corner, write in the name of the debt. In the upper right-hand corner, write in the total balance owed. In the lower left-hand corner, write the minimum monthly payment. Now, divide the total balance owed by the minimum monthly payment. In the lower right-hand corner, write in this number and circle it in red. The circled numbers are the number of months it will take to pay off that specific debt.
For example, if you owe $2,000 on your Visa credit card and your minimum monthly payment is $100, then $2,000/$100 = 20. Write “20” in the lower right-hand corner and circle it in red.
Do that for every debt on your list. If you owe money with no set minimum monthly payment, then decide what you want that monthly payment to be.
- Determine The Order for Paying off Each Debt
Looking only at the circled numbers of each debt, find the lowest number and place a #1 next to that debt. Find the next lowest number and write a #2 next to it. Continue to do that until there is a number next to each of your debts. Again, go from the lowest to the highest number. The circled numbers are the number of months it will take to pay off that specific debt.
- Find an Extra $100-$200 Per Month
This may sound a little daunting at first but brainstorm some ideas on how you could do this:
- Start a side gig
- Find items at garage sales or secondhand stores and resell them on eBay, other online auction sites, or online classified sites like Craigslist. After all, one man’s junk is another man’s treasure.
Face it, if you cannot come up with an additional $100 each month, then what do you think your chances are of becoming financially set in life? Probably pretty slim. If $100 per month is stopping you, then financial freedom will be nearly impossible to achieve.
You can find ways to earn extra money. You just have to get out of your comfort zone and get creative.
- Except for Your #1 Debt, Pay Only the Minimum Monthly Payment for Each of Your Other Debt
For this formula to work, pay only the minimum monthly payment due on each debt and put the extra $100 to $200 towards Debt #1. Therefore, for Debt #1, you are paying the minimum monthly payment required PLUS $100 to $200 extra.
Continue doing this each month until Debt #1 is completely paid off. Go back to your chart of debts and place a big red “X” through Debt #1. Now celebrate!
- Move on to Debt 2
For Debt #2, pay the minimum monthly payment required PLUS the full amount you were paying on Debt #1. Pay only the minimum monthly payment required for all other debts.
- The Monthly Amount You Paid on Your Final Debt—Invest It!
This process does not stop once you’ve paid off all your debts. This is the point where you go from being debt-free to becoming rich!
Take the total amount of money you were paying each month on that last debt you paid off and invest it. Do this every month. It’s very likely that the monthly amount has grown quite a bit since you started this process. Imagine having that much money every month to invest and, more importantly, to contribute towards you becoming financially free—never having to worry about money again and living the life you choose!
Investing with Debt
The bottom line is that, in order to become a successful investor, you first must put your personal finances in order. Simply said, if you have too much bad debt due to poor financial habits, please do not get into any more debt, good or bad. Once you get your personal finances in order and under control, you may be ready to go out and look for sound real estate investments to grow richer on.
Editor, Rich Dad Poor Dad Daily