The Best Way to Rebuild Your Credit

If you find yourself in a position where your credit score has dropped significantly, you may have trouble taking out a loan, applying for a mortgage, or getting a credit card. Luckily, there are several steps you can take to rebuild your credit. All that is required is some time, patience, and basic understanding.

5 Ways to Rebuild Your Credit

Rebuilding your credit can oftentimes be harder than starting from scratch. The purpose of rebuilding your credit is to show lenders that despite past mishaps on your part or even mistakes that you had nothing to do with, you’re still capable of making future payments on time.

Here are five examples of what you can do to rebuild your credit and be on your way to a better financial future.

1. Request, Review, and Correct Your Credit Reports

No matter what your credit situation looks like, it’s important to keep an eye on your credit reports and review them annually for accuracy. Your credit reports will come from the three main credit bureaus: Experian, Equifax, and TransUnion.

The easiest way to request your reports for free is by visiting AnnualCreditReport.com. You will use these reports for several steps in the rebuilding process.

Once you receive your reports, go over them with a fine-tooth comb. Make notes or highlight any errors on the report such as accounts that are not yours or accounts that you have paid but are still on the report. At the end of the report, you should find the contact information for having corrections made.

Send the bureau your corrections and file a dispute letter with any agencies on the report that have errors. Keep a file with copies of the letters and your report.

2. Pay Your Bills on Time

Surprisingly, this is one of the best ways to rebuild your credit. Your payment history consists of 35% of your overall FICO credit score, so keeping up a good track record is a necessity to improve your credit standing.

Set your calendar to remind you when bills are due or enroll in autopay. In today’s world of smartphones, computers, and online banking, there are multiple ways to ensure that you pay your bills on time.

3. Manage Your Spending

Another major factor in your overall credit score is your credit utilization ratio. If you keep higher credit card balances from month to month, your score will generally be lower than someone who carries a low balance or no balance at all on their credit card.

If one of your main issues is high credit utilization, do everything in your power to stop spending on the card and pay down your balance. The key to better credit is to keep your credit utilization ratio under 30%. If you’re not there yet, make a plan to get there and stick with it.

4. Get a Secured Credit Card

This product is normally for those who are building their credit from scratch but can be extremely helpful in the rebuilding process if you have credit card accounts that have been closed. A secured credit card requires that you provide a deposit up front that will determine your credit limit.

After you make that initial deposit and open the account, the card functions like any other traditional credit card. When shopping for a secured credit card, make sure to choose an issuer that reports to all three credit bureaus.

5. Get a Credit-Builder Loan

A credit-builder loan has one purpose; to help you improve your credit. This type of loan is typically offered by community banks or credit unions. In order to qualify, you will need to be a member at one of these institutions and provide proof of income and the ability to repay the loan.

Once you’re approved, you will make payments on the loan that are reported to the credit bureaus. Once your loan is paid off, the full amount is released to you. As long as you keep up with the payments, you should see an increase in your credit score.


Understanding Your Credit Report and Score

Before you can begin to rebuild, you will need to know what you are rebuilding and how it works. To start, it’s important to know that your credit score is based off of you credit report. Your credit report is data collected by the three main credit bureaus: Experian, Equifax, and TransUnion. This data includes:

  • Personal identifiers such as names, addresses, and your Social Security number
  • Financial account information such as loans, credit cards, mortgages, and other accounts associated with your Social Security number
  • Employment or income history if it has been reported to the bureaus
  • Judgments levied against you due to bad debt

This data is then compiled and used to compute your credit score. Each bureau has a different model for computing your score. Each lender uses a different company to pull your credit score, typically either FICO or VantageScore.


5 Factors That Affect Your Credit Score

Here’s a list of the top five factors in your credit report that affect your score the most. When reading through this list, ask yourself which factors could explain why your credit score needs some rehabilitation.

1. Payment History

Regardless of which entity is computing your credit score, your payment history is the most important factor. The most common payments on a credit report would be for a credit card or a car loan.

In order to rebuild your credit, you will need to stay on top of payments. If you come up short one month and cannot make the minimum payment, call your lender as soon as possible and see if you can make a payment plan to avoid harming your credit.

2. Credit Utilization

As mentioned earlier, your credit utilization is another factor that contributes to your credit score. The more debt you carry on revolving accounts like credit cards, the lower your score will be. Lenders want to see that you can handle credit responsibly and show restraint when credit is available to you.

3. Credit Mix

This is your account variety – installment and revolving. It carries a smaller weight in your overall score but is used as it shows responsibility in managing your credit.

4. Length of Credit History

The amount of time that you have had each account for is a factor as well. The longer you have credit and are able to manage it responsibly, the better. With that being said, even if you have mismanaged an account in the past, do everything you can to keep that account open.

For example, when you close a credit card account because you are too tempted to use it, this will end up harming your credit. When you close an account altogether, your credit history will not be as consistent or strong if you’ve had the account open for a substantial period of time.

5. New Credit Inquiries

There are several types of credit inquiries, soft and hard. Hard inquiries are requests that come from applying for a loan or credit card. These have a derogatory effect on your credit, especially if you are applying for multiple lines of credit in a short period of time. Soft inquiries will not affect your credit score.

Why Your Credit Score May Be Dropping

The downhill slide in your credit score doesn’t happen overnight. It occurs over a period of time and for many reasons. Here are a few of the most common:

Missing or Late Payments

You don’t have to skip payments for your payment history to have a negative effect on your credit score. If you are late making payments, the number of days you are late goes into your credit report. Whether you forgot to mail the check or weren’t able to make the minimum payment until a few days after the due date, it will reflect on your credit report and can drag your credit score down.

An Increase in Debt

If your credit utilization is high, your credit score will be negatively impacted. For instance, if you have $5000 in total credit lines and you have $4000 used out of this amount, your credit utilization is very high and pulls your score down.

FAST FACT: On average, Americans have $2,780 in credit card debt and $36,730 in mortgage debt.

New Credit and Credit Inquiries

If you open a lot of new accounts in a short period of time, your credit score will inevitably decrease. The credit bureaus and lenders see this as a sign of financial instability.

Another signal that you’re under financial stress is having a series of hard credit pulls in a short period of time. Don’t apply for every credit card offer that comes in the mail.


Things That Won’t Help Rebuild Your Credit

Your friends and family mean well. When you first entered the adult world of finances they may have offered you some advice on your credit. They might have not even realized that a lot of information that was passed along to them is simply not true and could even hurt you in the long run.

Keeping a small balance on your credit card to grow your credit.

Many people believe that you need to keep a small amount on your credit card balance to grow your credit score. This is simply not true. All you do when you do this is give the credit card more of your money in the form of interest.

In fact, the opposite is true. You should pay your balance off entirely or get it down as much as you possibly can every month to improve your credit. This fallacy was most likely created by a credit card company and has been passed around for many years.

Borrowing more money to pay off debt.

This is a common pitfall that will ultimately land you deeper in debt. Do not borrow from Peter to pay Paul. This old saying is as relevant today as it was 50 years ago.

Many lenders will take advantage of your situation. Payday loans and car title loans are perfect examples. You can’t borrow enough this way to get out of debt and what you do borrow comes at an exuberant cost.

Conclusion

You have several options when it comes to rebuilding your credit after a mishap or financial hardship. Make sure to request copies of your credit reports and carefully review them to locate any errors or points of improvement.

Once you have gone over your credit reports, make corrections as necessary and practice good credit habits like paying your bills on time and keeping your credit card balances low. This will help you maintain your score and increase it over time. Rebuilding your credit will not happen overnight, so remember to be patient with yourself and stay consistent.