Should You Ever Pay to Repair Your Credit?

Your credit score can affect many parts of your life. For starters, having good or excellent credit can help you land more favorable interest rates on borrowing or qualify for a credit card with better rewards. Over time, this can have a big impact on your finances.

Let's take just one example: Say you want to take out a personal loan of $5,000 with a three-year loan term. If your credit is outstanding, you might qualify for a loan with an APR of 10%, which translates to around $800 in interest. In contrast, if your credit score is subpar, you may wind up paying upwards of 30% -- if you can qualify for a loan at all. That could mean almost $2,650 in total interest payments. In that scenario, a significantly lower credit score would cost $1,850 more in interest over the term of the loan.

But it goes beyond mortgages, other loans, and credit cards. Your credit can also come into play in insurance premiums. Landlords may look at your credit score when deciding whether to rent you an apartment. Employers sometimes even consider it when you're applying for a job. With so much riding on one number, it's not surprising that there are over 40,000 companies offering credit repair in the U.S. According to IBISWorld, the industry's expected to be worth $6.6 billion this year.

What can cause a low credit score?

Your credit score is a bit like a grade you'd get in school, only in this case it reflects your ability to manage borrowed funds. A FICO® Score between 300 and 649 is generally considered to be poor or fair. According to The Ascent credit card research, around 25% of Americans fall into this category.

One big factor in calculating your score is payment history -- essentially, whether you pay your bills on time. Even one late payment can have a big impact on your score. If there are financial skeletons in your closet, such as a bill you never paid or a loan you defaulted on, this can weigh heavily on your credit for some time. Negative information can stay on your credit report for seven years, and bankruptcies even longer.

Another important factor is the amount you owe. Put simply, if you owe a lot of money it might be a sign that you're struggling to cover your day-to-day costs, making lenders cautious about lending you more. There are other factors such as the length of time you've had accounts and whether you have a mix of types of debt.

READ MORE: The Complete Guide to Your FICO® Score

Can a credit repair agency improve your score?

There are times when the right credit repair agency could help improve your score. But if there is accurate negative information on your credit report, no company can simply wave a magic wand and get rid of it. Indeed, if a company is promising to do this, be highly suspicious as it could be a scam.

What a credit repair agency can do is help you understand what's causing your credit issues and potentially negotiate on your behalf. It can also help you to challenge inaccurate items on your credit report that could be pulling your score down. Even then, be aware that fixing your credit could take years, with or without an agency's help.

The trouble is that some credit repair agencies engage in less-than-ethical and even outright illegal practices. For example, according to Equifax, some fly-by-night companies encourage people to lie on credit applications. Others may try to get you to hide negative information by getting an Employer Identification Number (EIN) from the IRS and using that as a type of clean slate. In itself, getting an EIN isn't illegal, but getting one under false pretenses is.

The biggest reason not to pay a credit repair agency is that you can take all the same steps for free. Many credit repair agencies charge upward of $70 a month, which can put a serious dent in your monthly budget. If part of the reason your credit score isn't stellar is that money is tight, you may be better off going it alone.

You can repair your credit on your own

Rather than shelling out your hard-earned cash, there are ways you can repair your credit yourself. Importantly, you'll be in the driving seat which means you'll know what's being done in your name. Start by learning as much as you can about how credit works. The more you understand, the better able you'll be to manage your credit.

Here are some steps you can take:

• Get a copy of your credit reports from all three credit bureaus. Normally, you're entitled to one free credit report from each agency every year, but pandemic provisions mean you can get free weekly reports until the end of the year. Go to annualcreditreport.com to get yours.
• Check your reports carefully. Look for any inaccurate information that could be dragging your score down. If you find anything, contact the credit bureau to dispute the information. You may also be able to negotiate with creditors -- if you can settle the account, they may agree to remove the negative line from your report.
• Get up to date on your payments. Paying bills on time is a surefire way to build credit. It isn't always easy, particularly if you're living paycheck to paycheck.

Bottom line

Reputable credit repair agencies can help you to repair your credit. But given the high costs and the fact that you can take the same steps for free, why not put that money towards other financial goals?