How to Rebuild Damaged Credit

Man uses calculator while looking through financial statements


low credit score can limit your financial muscle in all kinds of ways. It can prevent you from financing a home, make you pay higher rates when it comes to insurance and credit, and even keep you from being hired for the job you want.

If your credit has been damaged by hard luck or past mistakes, that doesn’t mean you have to live with a low score forever. With some discipline and patience, you can rebuild your credit.

Check Your Credit Report

Improving your credit can make life better in so many ways. The first step in beginning to repair your credit history is figuring out where you stand. The credit experts at Fair Isaacs Corporation, the company that created the FICO software model for calculating credit scores, say that checking your current credit report is a good first step. If you haven’t done so within the past 12 months, you can order a free credit report copy from each of the major agencies (Equifax, Experian, and TransUnion).

Find and Correct Credit Report Errors

Check each credit report carefully for errors. Don’t overlook seemingly small things, such as a misspelled name or wrong address. Also look for credit reporting errors (for instance, a reported outstanding debt that you have actually paid off) and make a note of them.

Once you’ve finished your review, contact the appropriate agency online (this is the only way Experian will accept corrections) and ask them to correct any errors you found. The Federal Trade Commission’s consumer website includes a sample letter for disputing credit report errors. Include copies (not originals) of statements or any other supporting documents. If necessary, also contact the creditor who submitted the erroneous information and tell them you’re disputing the information they submitted.

Once the correction process has been completed (this usually takes 30-90 days), you may be able to request another free credit report from the bureau in question to verify whether your information has been corrected. Check with the bureau to see whether you qualify for another free report.

Look at How Much Debt You Have

While you have your credit reports in hand, this is a good opportunity to add up exactly how much you owe and what your minimum payments are each month. You may be able to detect some behavior patterns or types of debt that got you into some trouble. Use this information to plan how you’ll change your credit behavior in the future.

Pay Bills on Time

Paying bills on time (or not) is the basis for more than a third of your FICO score. If late and missed payments have been a problem in the past, resolve to do better. Set up automatic notifications with your creditors if they offer them. That way, you’ll receive email or text reminders when your monthly payments are about to come due. Or you can set up automatic payments to be taken out of your checking account each month. Just make sure you have enough funds in your account when payment time rolls around to avoid overdrafts and their fees. However you decide to handle it, make prompt bill payments a priority and stick with it.

Pay Down Debt – But Be Careful About Closing Accounts

Reducing the amount you owe can go a long way toward improving your credit, but your overall debt load is only part of the equation. Lenders and credit reporting agencies also look at how much credit you have available to you. The relationship between your outstanding debt balances and the total credit available to you is known as your credit utilization ratio. Thirty percent of your credit score is based on your debt utilization ratio, so it carries a lot of weight. That’s why it’s important to think twice about closing out accounts once you’ve paid them off (more about this later).

Reducing Your Debt

If you were shocked when you added up the total of the debts reflected on your credit report, now’s the time to get serious about paying it down. Create a budget, stick to it, and direct all the extra funds you can each month toward paying off debt. As you put your plan in place, weigh the pros and cons of two different debt repayment methods – snowballing and stacking.  Choosing the right one for your temperament and situation may help you stay on track and pay down debt faster.

Think Twice Before Closing Credit Cards

Closing accounts as you pay off each balance may seem like a wise thing to do, but this could actually hurt your credit score by raising your credit utilization ratio. If your ratio is too high, that’s a signal to creditors that you may have more debt than you can reasonably handle.

A lower ratio is considered to be an indicator of responsible credit management. In general, experts recommend keeping your overall credit card utilization below 30 percent.

Points to Consider When Applying for New Credit

The credit utilization factor gets trickier when it comes to applying for new credit. Apply for new credit only if you need it, and not because you’re trying to improve your credit or your lower your utilization ratio.

That being said … if a rocky credit history has left you high and dry without any credit to your name, at some point you’ll want to start proving that you’ve turned over a new leaf. If you can’t get approved for a conventional credit card, a secured credit card may be the answer. With a secured card, you pay a security deposit up front ($500 is typical). The credit limit on secured cards is typically limited to the amount of the deposit, so the issuer isn’t taking on the financial risk.

Stay on Track

The good news is, it’s possible to repair a damaged credit history. The bad news is, it can’t be done overnight. It takes up to seven years for most negative items to drop off a credit report. For bankruptcies and unpaid tax liens, it can take as long as 10 years. Even credit inquiries stay on your report for two years. The process of building a stronger credit history is a marathon, not a race. It may take time and patience, but the payoff – a higher credit score and a brighter financial future – will be well worth it.