A reader named Amber e-mailed me recently and asked the following question about repairing her credit:
“I just settled all of my debt and got my credit score (not good) and printed off my credit reports. They all show that I have negative accounts and most of the accounts will be on until 2014, but I settled them all. What can I do to help build my credit now?”
It can be discouraging to emerge from a financial struggle (debt settlement, bankruptcy, foreclosure) only to realize that your credit score has hit rock bottom. As we’ve written about before, your credit score affects many areas of your finances, from what you pay for auto insurance to getting a job to buying a home.
So how do you rebuild your credit? In Amber’s case, she’s headed in the right direction. She’s settled all of her debts, has checked her credit report, and is tracking her credit score. But now what?
Remember that you can check your credit report for free at annualcreditreport.com. But that doesn’t give you your credit score. Fortunately, there are several ways to check your credit score for free.
Table of Contents:
Does Your Credit Report Have Errors?
Before we get to the steps to rebuild your credit, the first step is to make sure there are no errors on your credit report. It sounds like Amber has already done that. But if you haven’t, it’s quick and easy to do.
Once you’ve obtained a copy of your report, you should be looking for several types of errors:
Debts: You may find debts reported that either don’t belong to you, have been paid in full, or are listed in the wrong amount.
Accounts: Particularly if you have been the victim of identity fraud, you may see credit accounts listed on your report that you never opened or authorized.
Payments: You may see payments listed as late that you paid on time. You may also see that some creditors are not reporting your payment history.
Identification: You want to make sure your credit report accurately describes you. My report listed an incorrect address
Pubic Records: Credit reports include public records, such as adverse judgments. Particularly with identity theft, you may see pubic records items erroneously reported.
The key is to make sure there are no errors on your report. Correcting errors can be one of the fastest ways to improve your credit. If you do find errors, the Federal Trade Commission has put together an excellent article on how to correct errors on your credit report.
Rebuilding Your Credit Score
After you’ve addressed the negative items on your credit report and corrected any errors, it’s time to begin rebuilding your credit. To do that, you need to actually have and use credit responsibly. The problem is that it’s hard to get credit in the first place when your credit score is so low.
With that in mind, here are some tips to help you get started:
Get a secured credit card: If you have bad credit, you won’t qualify for most credit cards. One option is to get a card designed for folks with bad credit. The problem is that these cards often come with ridiculous interest rates. While your goal should be to pay off your card in full each month, that doesn’t always happen. With a secured card, interest rates are low and folks with bad credit can qualify.
The key is that these types of cards require you to make a cash deposit to secure your payment of future charges. As a result, your credit limit typically equals the amount of your deposit. These cards allow you to pick the amount of your deposit within a range. For example, the Capital One® Secured MasterCard® allows you to make a refundable deposit of up to $3,000. The best secured credit cards have low rates and will even upgrade you to a traditional credit card once your credit improves.
Liz Weston, THE credit score guru, recommends secured credit cards as a way to rebuild your credit in her excellent book, Your Credit Score: How to Improve the 3-Digit Number That Shapes Your Financial Future. It’s a must read for everybody looking to improve their score.
Buy a car: Just about everybody needs a car, and car loans can be had at reasonable rates even if you have bad credit. By making timely payments on a car loan, you’ll add positive history to your credit report. The key here, and this is critical, is to make sure the lender reports your payments to the three major credit bureaus. Most major banks and lenders do, but you need to make sure in advance of getting the loan. Otherwise, your monthly car payments won’t help build your credit score.
Pay everything on time: Missing a payment or two when you have stellar credit is not the end of the world, so long as late payments don’t become a habit. But with bad credit, it only exacerbates the problem. So as you work your way out of a credit crisis, it’s absolutely critical to pay your bills on time.
Keep revolving credit balances low: With any revolving debt, like a credit card, the goal is to pay the balance in full every month. In this way, you avoid paying interest on the debt. But if you do have a balance, you’ll want to keep it as low as possible in relation to your credit limit. For example, a balance of $1,000 on a card with a credit limit of $1,000 will be a significant negative mark on a credit report. That same $1,000 balance on a card with a $10,000 limit, however, will not. Maxing out on revolving credit is a signal that a person doesn’t have any financial flexibility should an emergency arise.
Don’t apply for lots of credit: Every time you apply for a loan, credit card, or other types of credit, the lender obtains a copy of your credit report. Called an “inquiry,” the credit bureaus keep track of every time a creditor asks for your credit file. Each inquiry can have a negative impact on your credit score. One or two inquiries probably won’t have much of an effect. But apply for a lot of credit from different companies, and the effect can be significant. So apply for the credit you absolutely need, and nothing more.
Finally, it’s important to be patient. Rebuilding your credit takes time. But if you take the right steps and manage your finances, your credit score will start to improve.