Budget Guides

Ultimate Guide to Rebuilding Your Credit

The following guide is presented for informational purposes only and is not intended as credit repair.

If you have poor credit, you’re not alone. It turns out that 20 percent of Americans have a FICO score of 600, which is considered to be subprime. While you may be suffering in good company, not having a solid score can hurt your chances in getting the best terms and rates with loans and credit cards, can limit your options for cell phone providers, and can even hurt your chances of renting an apartment.

Here’s the good news: with a bit of knowledge, commitment, and dedication, you can dig yourself out of having bad credit.

In our comprehensive guide, we’ll go over the basics of a credit score, what hurts your credit, debunk some common myths and misconceptions, and offer pointers on how to go about rebuilding credit.  

What’s in a Credit Score?

While FICO® and VantageScore® are the two most common credit scoring models for consumers, to keep things simple, in this guide we’ll refer to the FICO score.

The range for FICO credit scores is 300 to 850.

So how does your current score measure up? Here are the credit score categories:

Excellent: 800 to 850
Very Good: 740 to 799
Good: 670 to 739
Fair: 650 to 699
Poor: 550 to 649
Bad: 550 and below

So what’s in a credit score? There are five main parts, or factors that make up a FICO credit score:

FICO credit scoring breakdown

Payment history: 35 percent

Your payment history of both revolving credit, such as credit cards, and installment credit, such as an auto loan or a mortgage, show up on your credit report.

Amounts owed: 30 percent

Basically the total amount of debt you owe.

Length of credit history: 15 percent

How long all your credit accounts have been open.

New credit: 10 percent

How many inquiries for credit you’ve made in a period of time. Typically if you apply to open several credit cards within a few weeks, it’s a sign to lenders that you may be experiencing financial troubles.

However, if you are applying for a type of installment credit, multiple inquiries within a certain time frame (typically within a few weeks) count as a single inquiry.

Credit mix: 10 percent

This is your mix of loans, credit card accounts, retail accounts, and accounts with finance companies.  

Common Reasons Why Your Score Was Dinged

There are myriad reasons why your credit score may have been dinged:

High amounts owed

In turn, your credit utilization ratio, or total outstanding balance on all your cards against the total number of credit cards, also affects your score. The lower your credit utilization ratio, the better. It’s generally recommended to keep your credit utilization ratio below 30 percent.

You can use this calculator to figure out how much of your available credit you still have available.

Late or missed payments

For the FICO credit scoring model, your payment history makes up 35 percent, which is the lion’s share of your credit score. Late payments usually stay on your credit report for seven years.

Errors on your credit report

Not all errors on your credit report negatively impact your score. For instance, typos on your personal information and previous addresses won’t ding your score. However, mistakenly reported late payments will impact your score.

Opening new credit accounts in a short amount of time

Opening a bunch of new accounts in a short period of time is indicative that you may be financially stressed. Therefore, it could negatively impact your credit. However, a number of hard pulls within a specified time period is okay. That’s because it indicates you are applying for new credit.  

Myths About Credit Scores

What you don’t know can hurt you. There are common myths that could cause you to make moves that actually damage your credit:

"You need to keep a balance to maintain a good score"

Credit myth - you need to maintain a balance on your cards

While your credit utilization ratio does affect your credit score, you do not need to maintain a balance whatsoever to keep a solid score.

Keeping a balance will just cost you more in the long run, because you’ll be paying more in interest. Ideally, you would like to pay off your balance in full each month. It’ll keep your credit score in tip-top shape.

"There is only one credit score that all lenders look at"

According to the same NerdWallet survey, most people have many credit scores. These scores may differ based on the type of information factored in to calculate the score. The scoring model and provider the lender is looking at depends on what you’re applying credit for. For instance, there are credit scores specific to auto loans and mortgages.

"You start with perfect credit"

Credit myth - Everyone starts with great credit

According to a NerdWallet survey, 11 percent of Americans think we start with a perfect credit score. In fact, while you don’t start at zero, you do have to build your credit over time. So if you don’t have a long credit history, you’ll need to work at boosting your credit.

"Every time your credit report is pulled, your credit score takes a dip"

When your credit report is pulled, it’s considered either a “soft” pull or a “hard” pull. A hard pull is when you’re applying for a line of credit or loan, and the lender needs to check your credit report beforehand.

However, if it’s a “soft” pull, such as when you check your own credit, a potential employer reviews your credit, or when a lender sends you a “pre-approved” loan, they may check your credit before extending an offer. In any of these cases, your credit score will not be affected.

How to Rebuild Your Credit Score

Now, on to the good stuff. Here’s how you can go about rebuilding your credit:

Order a Credit Report

You can order one a year from each of the three major credit bureaus—Experian, Equifax, and TransUnion. There’s only one site that is truly free: AnnualCreditReport.com.

Because you can order one from each credit bureau a year, to make sure your credit is accurate and up to date, you can stagger and order one every four months.

Beware of sites that claim you can order a free credit report. Often they they may charge you an annual fee.

While the credit report is free, if you want to check your credit score, there may be an additional cost. Nowadays many money management apps, credit cards, and credit monitoring sites offer consumer credit scores free of charge. However, their scoring system may be different than the FICO® or VantageScore®, so your credit score may be slightly different than that of a credit bureau.

Hunt for Errors

Certain errors (i.e., report of missed or late payments) may negatively impact your credit score. If that’s the case, you’ll want to reach out to the credit bureaus and file a dispute. To file a dispute, connect directly with each credit bureau:

The credit bureaus generally have 30 days to investigate a dispute.

Pay off or settle outstanding collection debt

You may be inclined to just ignore old collection debt, assuming it can't hurt you any worse than it already has. But it's important to note that $0 balance collection debts don't impact your score in most newer credit scoring model. This makes paying off or settling old debts substantially more worth your while. Simply clearing away old collection debts from your credit report can lead to a potentially huge improvement to your score.

Stop Doing What Got You in the Situation

Pinpoint what it is that damaged your credit, and stop doing it, explains credit card expert John Ulzheimer, formerly of FICO and Equifax. For instance, if you have a high balance on your cards, temporarily put a freeze on a few of them. Or see if you can do a “cash-only” spending plan, or stick to using your debit card for purchases. If late or missed payments is what dinged your credit, make sure you pay on time.

Open a secured credit card

You may be wary of getting back into the credit game, but unfortunately the only way to build a strong credit score is to use credit responsibly. That means that you need to have at least an open credit card account that you use occasionally.

If your credit score is low (or nonexistent) you may not qualify for prime credit card offers. Instead, your best bet may be to open a secured credit card. To offset the risk for the lender, secured cards require that you deposit an amount equal to the card's credit limit (typically around $500). The deposit ensures that even if you default on your debt, the lender can simply collect what's owed from your deposit.

After six months of good behavior, most lenders will convert your secured card to a standard card and return your deposit. 

Alternatively, you may want to investigate subprime credit card offers, although these will often come with high interest rates and low credit limits. However, as long as you repay your debt in full each month, those interest rates should be manageable, and with time you'll be able to upgrade to a card with better terms.  

Open a credit builder loan

Similar to a secured credit card, a credit builder loan is a low risk way for a lender to help you build your credit profile. Not every financial institutions offer this product, which is more popular with credit unions and smaller, local banks, so you may need to look around.

When you take out a credit builder loan, the lender actually keeps the loan funds. You "repay" the loan each month. Once you've repaid the full loan amount, the funds are released to you, and your credit score has hopefully improved in the process. With both credit builder loans and secured credit cards, you'll want to ensure that your payments are being reported to the credit bureaus.

Make On-Time Payments

Because payment history makes 35 percent of your credit score, it’s in your best interest to make the minimum payments on your debts. If you can, set your payments to go out automatically so you don’t miss a beat.

If it might be helpful, reach out to your lenders to see if they can change your payment due date so that it coincides with your paydays, or so you aren’t paying all your bills at once.

Want to make killer moves on paying off your debts? Aim to make two payments a month, or even weekly.

Keep Your Debt Low

As credit utilization ratio makes up the “amounts owed” portion of your credit score, you’ll want to keep your credit utilization as low as possible. Credit utilization is your total outstanding balance against the spending limit on all your cards. For instance, if you have a total of $4,000 and your total credit card limit is $40,000, then your credit utilization is 10 percent.

Stick to Your Repayment Plan

Sit down and figure out your total debts, including the lender, fees, and interest rates. List them in order of interest rates. Then, figure out a debt payoff method that best suits you.

“Paying on time isn’t terribly difficult, but paying down debt can be a real challenge, especially if your credit card payments are already straining your budget,” explains consumer credit expert Kimberly Rotter. “My number one suggestion would be to pick a payoff strategy and commit to it,” says Rotter.

There are two popular types of debt payoff strategies:

Avalanche Method

With the avalanche method, you focus on your debts with the highest interest rates first. Essentially, you pay the minimum on all your debts, then put everything left over toward that highest interest rate account. When you are done paying off the first debt, you can move on to the next highest interest rate. Because you are knocking out the debt with the highest interest rates, this method generally helps you save the most money.

Snowball Method

Conversely, the snowball method is when you prioritize the debt with the lowest balance first. Once that’s paid off, you move on to the debt with the next lowest balance. While you may save more on the interest with the avalanche method, some people opt for this because as you’ll be able to knock off individual debts sooner, which can help keep you motivated.

Debt repayment - snowball vs. avalanche

Prioritize Your Debts

While you may be juggling multiple financial priorities—paying your basic living expenses, saving for an emergency fund, retirement, a house, or for your children’s higher education—keep your debt top of mind.

After you come with a repayment plan, make sure you adhere to it. If your current financial situation should change, make necessary tweaks.

Start Small

If you are struggling financially to keep up with your payments, just make the minimum payments at the very least. If you can, pay a little extra each month.

Do One Thing a Day to Improve Your Finances

Rebuilding your credit takes commitment, dedication, and persistence. Rotter suggests doing one small thing each day to improve your credit card score. “You might not think a dollar can make a difference,” explains Rotter, “but if you can pocket a dollar every day, that’s a $30 extra monthly payment toward a bill looming over your head.”

Rotter started her own debt payoff using the avalanche strategy with an extra $25 a month. Once her first bill was paid off, she added the minimum payment (about $30) and the extra $25 a month to the minimum payment on the next bill. “If you keep paying back more than you spend every month, eventually you will come out on the other side.”

Increase Your Credit Limit

By increasing your total credit limit, you could lower your credit utilization ratio. For instance, if your total outstanding balance is at 40 percent, increasing your spending limit on a card or two could bring down your credit utilization to 30 percent.

If you are upping your credit credit limit, a word of caution: just be sure not to spend more. That will null any efforts to boost your credit score. It might help to set alerts on your credit cards for transactions over a certain amount, or when you’ve hit a certain amount.

Use a credit booster service

Historically, credit scores have been based primarily on how we handle loans and credit cards. Of course, those aren't the only financial responsibilities we balance each month. From rent to electricity to Netflix, you're likely making timely payments on a variety of services that don't show up on your credit report.

Credit boosting services, like Experian Boost, help you get credit for those "other" payments that you never miss. Keep in mind, these services may cost money and the scope of what they can do for you and your credit will change depending on the service, so be sure to review the terms closely to make sure that the benefits outweigh the cost. But if you need to increase your score by a few points, it's worth investigating. 

Be Patient

It likely took years to damage your credit so it will take time to rebuild, explains Ulzheimer. “Time certainly is your ally and as your negative entries age, they will lose negative value in your credit scores, and eventually they will fall off of your credit reports.”

“Financial health does not come in a week or a month, or sometimes even in a year,” adds Rotter. “It’s easy to get burned out on a frugal lifestyle if that’s how you’re trying to pay down debt. Just remember that you’re making a long-term investment in yourself. You’ll lower your stress and increase your happiness when you learn how to handle credit and finances responsibly.”

Many people believe it takes years to rebuild credit. “That's simply not true,” says Ulzheimer. “It may take years to turn a credit score of 600 to an 800, but you can certainly enjoy the ascension of your score along the way much sooner.”  

Continue to Check Your Credit

You can monitor your progress by checking in on your credit score periodically. Don’t forget that you can order up to three credit reports—one from each of the three major credit reporting bureaus—within a 12-month period.

Credit rebuilding checklist

Hopefully by now you feel better informed and well-equipped to tackle rebuilding your credit. While it may take time to rebuild your credit, with the proper know-know and resources, you’ll boost your credit score.

If you have questions on how to improve your credit score, contact a Money Management International (MMI) to learn more about understanding your credit report or overcoming credit card debt.

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