Rebuilding Your Credit After a Financial Crisis

Introduction

When your credit score takes a hit, recovery can seem overwhelming. And that’s true whether you’ve filed for bankruptcy, or an emergency like a medical crisis caught you off guard. In fact, even some major life events can impact your credit score in unexpected ways.

Of course, avoiding these dings in the first place would be an ideal scenario. But that’s not always possible. So the next best thing is to lessen their impact by immediately making an effort to rebuild your credit.

What Hurts Your Credit Score the Most?

A few things can severely damage your credit. So before making positive changes, it’s important to know which issues can have the biggest negative impact.

• Bankruptcy: Declaring bankruptcy has one of the most severe and long-lasting effects on your credit score, with the potential to lower your score by 100 to 200 points, and stay on your credit report for 7 to 10 years.

• Foreclosure: Losing a home to foreclosure can drop your credit score significantly and it stays on your credit report for up to 7 years.

• Repossession: Having a vehicle or other financed item repossessed can also stay on your credit report for up to 7 years, and the related missed payments can drop your credit score further.

• Late or missed payments: Not every negative impact to your credit score is from a major crisis. Late credit card payments and missed payments are some of the most common ways people damage their credit, and each missed payment can stay on your credit report for up to 7 years.

Regardless of what caused your financial setback, it doesn’t have to be permanent. Financial difficulties in the past can be fixed in the future, but rebuilding your credit takes time and effort.

Talk to Your Creditors

The first thing to do if you’re falling behind on payments is to talk to your creditors or lenders. They may be willing to help you get your account current by lowering your interest rate, extending the term of your loan, or perhaps reducing the total balance you owe.

Even if you already have late or missed payments on some of your accounts, it’s important to keep making payments instead of letting the accounts go to collections. The impact of a charge-off, repossession, or foreclosure on your credit score is typically worse than the impact of a delinquency.

What to ask for

You can request a few different solutions, depending on your situation. It’s a good idea to go in knowing your options.

• Goodwill adjustments: Your creditor might agree to remove a late payment from your credit reporting as a one-time courtesy if you were previously in good standing. 

• Payment plans or forbearance: Your lender may offer hardship programs or modified payment plans if you let them know you’re going through tough times. 

• Credit-building resources: Your creditor might also have unique training or educational resources, so it’s worth asking for advice on how to improve your credit score.

Get Current on Payments

Once you’re behind on payments, your situation can start snowballing into bigger issues. It’s important to catch up as soon as possible. Bringing your accounts up to date and making your payments on time going forward will help you re-establish a solid payment history. The sooner your accounts are current and you’re consistently making on-time payments, the sooner your credit score is likely to start moving up.

Consider Working with a Credit Counselor

If getting your finances back on track is too much to handle on your own, consider working with a reputable non-profit credit counseling organization. This isn’t the same as a debt repair or debt settlement service.

Credit counselors evaluate your complete financial picture and help you develop a plan to get your debts paid off and your accounts in good standing. They can provide guidance on a variety of financial topics, including budgeting and debt management.

Monitor Your Credit

The best way to see how you’re doing is usually by pulling your credit report, which you can do for free (and with no ding to your score) once a week at AnnualCreditReport.com. Getting all three reports lets you see a bigger picture since not all creditors report to all three credit bureaus.

The first thing to do is check your credit reports to make sure all the reported info is accurate. If it’s not, dispute the errors right away so it can be resolved as quickly as possible.

If you don’t see any mistakes, analyze the negative line items to see what’s harming your score. You can’t remove negative information if it’s accurate, but the effects typically diminish over time once you start establishing positive credit habits.

So don’t panic. Even if you have a long list of delinquencies, missed payments, and charge-offs, it’s possible to get back on track with some effort.

Consider a Store Credit Card

A lot of major retailers have their own credit cards, including department stores, clothing stores, electronics stores, and home improvement centers. These cards come with pros and cons, but they’re typically easier to get than major credit cards. If you get approved for a store card, that can let you get started again on your credit-rebuilding journey.

Of course, you’ll want to make consistent, on-time payments to rebuild your payment history. Otherwise the card does more harm than good. And pay off your full balances when you can, because interest rates on store cards are often higher than other types of credit.

Take Advantage of Secured Credit Options

If you don’t want or can’t get a store credit card, you still have options. Opening new accounts when you’re rebuilding your credit is tougher than when you have good credit, but it can be done. If you’re not able to qualify for an unsecured loan or line of credit, consider getting a secured credit card instead.

Secured credit options are typically the easiest type of credit to qualify for since you have to deposit a certain amount of money into an account as collateral. That deposit is often the same as your credit line, so a $300 deposit would get you a $300 credit limit.

If you default, the lender can use your security deposit to pay off your account and cover their losses. Otherwise, you’ll likely get it back when you’re done with the card. And if you use it strategically, a secured card can help build your credit like any other credit card. Secured card issuers will typically report your activity to the credit bureaus for this reason.

How To Get a Secured Credit Card

It’s relatively simple to get a secured card once you have your deposit ready.

1. Shop around. Secured cards vary, so start with researching what’s available and comparing your options. Take a look at any fees, the interest rate, rewards or other benefits, and credit reporting opportunities. The last point is most critical because it’s the main reason people get secured cards.

2. Submit an application. This step is similar to other credit applications. You’ll usually need to supply personal details like your name, address, Social Security number, and monthly income. 

3. Wait for approval. After reviewing your application, the creditor will decide whether or not to approve you. If they do, you should receive notice of the required deposit. 

4. Make a security deposit. Some cards offer a choice for the deposit amount, and others have a predetermined requirement. Either way, your deposit amount will often be the same as the card’s credit limit.

When you eventually close out the secured card or graduate to an unsecured card, you can usually receive a refund of your security deposit. 

What Impacts Your Credit Score?

If you want the best credit-building results, it’s helpful to know exactly how your credit scores are calculated. Different credit scoring models, like FICO and VantageScore, put more weight on different things. But they’re usually similar.

Here’s a quick breakdown of the five key factors that specifically affect your FICO Score (versions 8 through 10) as of 2009 when FICO 8 first launched.

1. Payment history is worth about 35% of your score. It includes whether or not you pay your bills on time, and how much you pay.

2. Credit utilization counts for about 30% of your score. This ratio shows how much of your credit limits you’re currently using.

3. Length of credit history is worth approximately 15% and considers how long you’ve had credit accounts open.

4. Credit mix is worth about 10% of your score. This includes the different types of credit you may have, like credit cards as opposed to installment loans.

5. New credit is worth about 10% of your score. This looks at the number of new accounts in your name, which could be good or bad — but applying for a bunch of new cards is usually negative.

All of these areas work together like the instruments in an orchestra. Your goal is to play beautiful music, so here’s how to make sure they’re all tuned up and ready to help rebuild your credit.

Step 1: Improve Your Payment History

Payment history has biggest impact on your credit score, so paying on time, every time, is one of the best things you can do for your credit score. Paying early can be even better.

On the other hand, late or missed payments can have a serious negative impact, and may stay on your credit report for up to 7 years.

Paying your balance in full isn’t required for positive payment history — you simply have to pay at least the minimum due. However, paying off your balance accomplishes a few things. First, it saves you money on interest charges, especially if you leverage your grace period.

But it also helps keep your credit utilization rate lower, which could have a positive effect on your score too.

Quick tips for consistent payments

A few simple strategies can help you make sure you don’t miss your payments.

• Set up AutoPay for at least the minimum due.

• Use calendar reminders and notifications for due dates and automatic withdrawals.

• Consider paying early, like mid-cycle, to save on interest and lower the credit utilization being reported to credit bureaus.

Step 2: Watch Your Credit Utilization

Credit utilization is an important credit scoring factor because it counts for up to 30% of your overall credit score. Experts typically recommend using only 30% or less of your credit limits, but keeping balances below 10% is even better.

What is a credit utilization ratio?

Credit utilization is the percentage of your total credit lines that you’re currently using. It can also be calculated on each individual card.

How is your credit utilization score calculated?

Your credit utilization ratio is a simple equation. To figure out yours, just divide your total outstanding credit card balances by your total credit limits. Then multiply by 100 to get a percentage.

Let’s say you have two credit cards. One has a limit of $2,000 and the other $3,000 for a total limit of $5,000. You’ve charged $1,200 to each card for a total balance of $2,400.

$2,400 ÷ $5,000 = 0.48 so your aggregate credit utilization ratio is 48%.

You can also calculate individual utilization, which would be 60% on the card with a $2,000 limit and 40% on the one with a $3,000 limit.

This is considered relatively high, and credit scoring models see high utilization as a sign of risk. Using too much of your available credit makes it look like you’re overextended, even if you’re doing everything else right.

A lower credit utilization ratio shows you don’t need the credit, which in turn makes lenders think you’re more responsible. And that helps improve your credit score, which is exactly what you need when you’re rebuilding.

What is a good credit utilization rate?

When you first hear about recommended utilization, it might seem shockingly low.

• Under 30% is recommended

• Under 10% is even better

The higher your balances go, the more they typically impact your credit score.

Tips to improve your credit utilization

Keeping your credit utilization at an optimal level takes a bit of effort, but it’s usually worth it. Follow these simple tips to make it easier.

• Know your limits — literally. It’s easier to keep your balances within range if you know what that range is. 

• Pay down existing balances, or pay them off if possible. 

• Make multiple payments throughout the month if your creditor allows it. Smaller amounts add up and they’re often easier to manage.

• Request a credit line increase — but leave the new credit available instead of spending more on the card. 

• Spread purchases across multiple cards so your individual utilization remains low as well as aggregate utilization.

Step 3: Don’t Close Old Accounts or Open New Ones

If you’re tempted to revamp your whole financial infrastructure in the hopes of rebuilding your credit score faster, take a pause. Closing or opening accounts can have a bigger impact than you might think, so you’ll want to keep a few things in mind.

What to avoid

These two common activities could have a detrimental effect on your credit score, but for different reasons.

• Closing older accounts: Even if you’re not using them much anymore, closing older credit cards can shorten your credit history and average age of your accounts. The size of the impact depends on a few factors, including the credit scoring model being used.

• Closing a credit account can also raise your credit utilization ratio by reducing your overall available credit, and make your credit mix less diverse — especially if you don’t have other credit cards. All of these factors can ding your credit score.

• Opening too many new accounts: If closing accounts is bad, opening them should be good, right? But not exactly. Applying for a new credit account usually results in a hard credit inquiry, or hard pull. This can reduce your credit score by a few points, and applying for multiple cards will amplify the effect.

“New credit” is also worth about 10% of your total FICO Score, so too many new accounts and credit inquiries can lower your score there as well. This is because opening several new cards in a short period of time can paint you as desperate for credit, which is considered a higher risk for lenders.

What to do instead

The situation might seem confusing, but the solution is relatively simple. If you have older credit accounts in good standing, keep them open, whether you use them often or not.

• They can lengthen your credit history and increase the average age of your accounts, which may contribute positively to your score. 

• They can increase your available credit and help keep your credit utilization low, as long as you don’t fill them up. 

• They can help establish positive payment history by giving you an active account for making timely payments.

Step 4: Build a Safety Net With an Emergency Fund

If you don’t have savings available, you’re more likely to rely on credit cards in an emergency. And an unexpected medical bill or car repair could rack up overwhelming debt instantly. But starting an emergency fund can give you the cushion you need.

 As you may have heard before, the standard recommendation is to save up three to six months’ worth of living expenses. That can feel unrealistic when you’re just starting, but putting aside a little bit each week adds up over time.

• Saving small amounts like $10 to $25 a week can get the ball rolling and establish a habit. 

• Set a short-term goal of $500 or $1,000 as a starter fund. 

• Work toward mini milestones, like having one or two paychecks’ worth of savings on hand. 

• Set up automatic transfers to build your savings without having to think about it. 

• Remember that consistency is more important than the size of your fund.

How Long Does It Take to Rebuild Credit?

Whether you’re building credit from scratch or rebuilding after a financial crisis, it’s going to take some time. Depending on how serious the crisis was, it could take months — or even years — to bring your score back up to where you want it.

During this time, the best course of action is usually a strategic and deliberate approach to your personal finances, even for things that don’t get reported to the credit bureaus.

A good approach is to create a realistic budget based on your income and expenses. You might need to eliminate or cut back on certain purchases so you can restore your financial health. Saving for an emergency fund can also help you avoid going into debt the next time you have an unexpected expense.

FAQs

If you’re still unsure about how to rebuild your credit, we’ve answered some frequently asked questions for you.

What financial events hurt your credit score the most?

Simply failing to pay on time and carrying too high a balance can damage your credit score more than you might think. But generally speaking, bankruptcy and foreclosure may hurt your credit score the most, and can remain on your credit report for up to 10 years. Having your account sent to collections for non-payment is very damaging as well.

What’s the first thing I should do to start rebuilding my credit?

Step one is often to pull your credit report and check for any errors. That alone won’t help you rebuild, but it does help you understand the landscape and correct any unnecessary damage from incorrect data. The next thing to do is find a way to re-establish your track record of on-time payments. If you don’t have an account to make payments on now, a secured credit card is a great tool for this.

Can paying bills on time really improve my credit score?

Yes, paying bills on time is one of the best ways to improve your credit score. Payment history is worth 35% of your FICO Score and 40% of your VantageScore 3.0 (launched in 2013), which is more than any other factor. This makes on-time payments crucial, and missed payments extremely harmful.

How does credit utilization affect my score during recovery?

Credit utilization is the second-biggest factor for credit scores, weighing in at 30% for FICO and 20% for VantageScore. You may feel like you need to use all your available credit to get by, but maxing out your cards is quite detrimental to your credit score. This one move makes it look like you’re careless with credit, which lenders equate to being a risky borrower.

Should I close credit cards that were maxed out during the crisis?

Generally no, you shouldn’t (and probably can’t) close a card with a balance, and neglecting to pay your credit card debt will likely damage your credit further. However, the answer to this question largely depends on what the crisis was and what happened afterwards.

If you declared Chapter 7 bankruptcy, your credit card debt may have been eliminated during that process. If you filed Chapter 13, you may have been given a payment plan for that debt.

Can a secured credit card help with rebuilding credit?

Yes, a secured credit card is one of the best ways to rebuild credit when you can’t get an unsecured card. Once you pay the deposit, it works like any other credit card to help you build positive payment history.

How often should I check my credit report while rebuilding?

General advice is to check your credit reports at least once a year. But when you’re rebuilding credit, you’ll probably want to do it a lot more often so you can see what’s happening and catch any errors before they become issues. You can get each report for free once a week at AnnualCreditReport.com.

Will debt consolidation help my credit improve faster?

It depends. If you have a credit card with a 0% APR offer on balance transfers, moving your higher-interest balances to that card for consolidation could make sense. But using a debt consolidation service can sometimes backfire if they ask you to stop paying while they negotiate on your behalf.

Bottom Line

Rebuilding your credit can be a long journey, but it’s extremely worthwhile for getting your financial life in order. Good credit doesn’t just help you get better credit cards. It can also be crucial for getting more desirable rates and terms on loans, car insurance, rentals, and utility bills.

If you need a new credit card to help you down that road, you might qualify for one that’s dedicated to rebuilding credit. Seeing if you pre-qualify won’t harm your credit score, and you can always fall back on a secured card if necessary.