Rebuilding Your Credit After a Big Hit

Rebuilding credit is a lot like trying to lose weight. We wish there was a quick, overnight fix—that somehow regardless of our diet or exercise habits we will magically wake up tomorrow 20 pounds lighter.

Unfortunately, just as with weight loss, repairing your credit after a financial calamity like declaring bankruptcy or losing your home to foreclosure takes time, patience, and dedication. But it is possible.

How bad is it?

Before you start putting together a strategy to rebuild your credit, it’s important to put in perspective how bad (or not so bad) things really are. Experian, one of the three major credit reporting agencies, gives these credit ranges as a guide.

  • Above 740: Excellent
  • 670 – 739: Good
  • 580 – 669: Fair
  • Below 579: Poor (or No Credit Score)

Along with your credit score, there are other factors that may keep you from being approved for credit that you need to try to avoid, including:

  • Debt-to-income ratio above 50%
  • No credit score/history
  • Piling up debt in a short period of time
  • Unemployment

Where to start

Similar to the ways we describe elsewhere in this issue on how to establish or boost your credit, some of the same themes and principles may also be applied when trying to rebuild your credit:

Know where you stand

First things first, you need to know where you stand creditwise. Check your credit report to see exactly where you need to improve. Looking over your report, do you have a lot of missed or late payments? Is your debt utilization too high? These problem areas are the ones you need to tackle first.

You’ll also want to check your credit report for any errors or fraudulent accounts. If something is inaccurate, be sure to report it to the three major credit bureaus, Experian, Equifax and TransUnion. The FTC offers great information on disputing inaccurate information, as well as a helpful sample dispute letter you can use.

Play catch-up on your payments

Payment history comprises 35% of your credit score and is the factor with the most impact. If you are behind on your payments, you won’t be able to improve your situation. Try to bring all of your accounts up to date. If you can’t afford to pay everything at once, contact your creditors and work out a payment plan. Explain your situation honestly, and let them know that you are working toward repaying your obligations. Let them know how much you can pay, and how long you expect to make payments.

You can also seek the services of a legitimate credit counseling agency to help you create a plan.

Pay bills on time, every time

Going forward, commit to paying your bills on time, including utility bills and rent payments. Establishing a reliable pattern of on-time payments is vital to rebuilding your credit. Consider setting up automatic payments or payment alerts to avoid late or missed payments in the future.

Don’t close old accounts

Once you’ve paid off an account, when possible, avoid closing it. Simply put, the longer your credit history, the better your score. Even if you no longer use the card, it’s best to keep your older accounts open if you can so that you have a substantial credit history.

Pay down your debt

The second most important factor in your credit score is your credit utilization—basically how much you owe. Once you’ve caught up on your late or missed payments, it’s time to tackle your existing debt. If you are using a great deal of your available credit, it can count against you. Create a plan to pay down your debt a little faster. Take a hard look at your expenses, and see where you can cut back. Maybe a second job or freelance work is required to help boost your income. Experts recommend keeping your credit utilization to 30% or less. So, for example, if you have a credit card with a $10,000 limit, you will want to keep the outstanding balance on the card to less than $3,000 at all times.

Consider an installment loan

Part of your credit score is based on the types of account you have and there are two main types: revolving and installment. A revolving credit account is like a credit card or a home equity line of credit, where you have an available limit and free up funds as you pay down the loan. An installment loan has a set term and set payment, like an auto loan or mortgage.

Persistence pays off

Similar to dieting, it can take 2-3 months or longer for you to start seeing results in your credit score. Depending on how bad the situation is, it can take two or three years to see solid improvement to your credit history. Develop good financial habits of living within your means, saving money in an emergency fund, paying bills on time, and saving for the future. Stick to your credit rebuilding plan and before you know it, you’ll be rewarded with better rates, lower interest fees, and more available credit when you need it.

References: MagnifyMoney, Wisebread, FICO