Your Three-Step Plan for Rebuilding Your Credit

(Patience, determination – and a plan – can get your finances back on track.)

Your three step plan for rebuilding your credit

Few of us are exactly where we would like to be when it comes to our financial situation. Getting into a financial hole can have serious consequences, including lowering your credit score. Improving and rebuilding your credit score can have many positive effects on your financial situation, which makes it a priority item for anyone looking to get back on track. 

Step 1: Review Your Credit Report

You can get all three of your credit reports once a year at absolutely no cost to you, by going to the Annual Credit Report website. Focus on simply obtaining your credit report and don’t sign up for any additional services that you have to pay for, such as credit monitoring. 

Once you obtain your reports, review them and look at the most recent negative entries. Erica Sandberg, editor-at-large at the Credit Card Guide website, advises that you consider these negative entries by asking “How recent is this entry, how severe is its effect on my credit, and how frequently do such entries appear on my credit report?”

Certain negative entries on your credit report will carry much more weight than others, with the worst entries being bankruptcies, judgments or other public record items, charge-offs, and late payments. Negative entries have a worse effect on your credit if they appear recently and with any amount of frequency. 

Angel Rich, founder and CEO of the Wealth Factory, advises, “First, make sure none of the entries are duplicate entries for accounts where the original creditor charged off and they have been bought by more than one collection agency.” Those charges should only appear on your report one time, so you can dispute any duplicate entries or other incorrect information. 

Then, she says, “Categorize the debt by type so you understand what you have on your report.” When rebuilding your credit, you should focus on the most recent debt first (within the last 2 years) and work toward paying off the lowest amounts first. It’s also critical to avoid late payments, so make sure you’re making the minimum payments on time, every month. 

You may also be able to settle some of the debt for a lesser amount and make a payment plan to pay it off. “In some situations, you can even provide a down payment on a settlement, have the debt removed from your credit report, and repay the remaining balance on a payment plan,” says Rich. 

Both credit experts agree that some debts should be allowed to fall off your credit report if they are close to the 7-year expiration date. 

After you’ve reviewed your credit and have started to pay off debts, you can begin to plan for the next step in rebuilding your credit. 

Step 2: Rebuild Your Credit with Positive Entries

Paying off existing debts on time should be your priority and will make the biggest difference in rebuilding your credit and getting you back onto a strong financial footing. Sandberg says, “As long as you’re repaying that old debt, you’re adding new, positive entries to your credit report and increasing your credit score.”

However, Rich cautions to “Not get any new credit for at least one year after you start paying off old debt.” Put your efforts into cleaning up your old debt and don’t add any new inquiries to obtain new credit.

After about one year of positive entries, you could consider adding a new credit source, such as a secured credit card or personal loan. But the goal should still be to pay off this new credit on time so that your credit score continues to show positive entries. Be careful not to get into new debt with your new credit source. Sandberg adds, “Establish new credit so that you will have positive entries on your report that shows you can pay bills on time. That will raise your credit score.”

One type of loan you could consider is a car loan. Try to pay a larger down payment so that your loan balance is lower, but make sure you can pay it on time. 

An important aspect of rebuilding your credit is not using all of your available credit. If you have a $10,000 credit line, try to use no more than 30%, or $3,000, of your line at any one time. Not maxing out your available credit will help improve your credit score and may eventually secure you a higher credit line once your score improves.

Rich suggests setting a goal of having no more than 20% of your income as credit debt. This will help you manage your debt properly and keep your credit score high.  

Step 3: Pay Your Bills on Time

Paying your bills on time is critically important in rebuilding your credit because it shows financial responsibility. Try to avoid making last-minute payments as well, because the payment may take longer to process and could be reported as a late payment. 

“On time means your payments should be made to the creditor at least 5 days before the due date so they can be posted on time. The grace period is for emergency situations, not to give you extra time to pay,” says Rich. 

If you set up your debt payments for automatic withdrawal from your bank account, try to change the withdrawal date so that the payment is taken out well before the due date. Automatic payment schedules are normally set to be withdrawn on the same day as the due date, which could lead to a late payment and a negative credit entry. 

You may have to temporarily change your spending behavior in order to make sure you can pay at least the minimum amount on time each month. Remember that you’re working toward a goal, which may mean you’ll have to sacrifice in the short term so that you’re better off in the long term. 

By following these 3 steps, you should see a significant improvement in your credit score after 2 or 3 years. At that point, you’ll be able to reevaluate your financial situation, and you may be in a position to buy a home or start working on another financial goal. Restoring and rebuilding your credit does take time though, so you’ll need to be patient and stay focused to achieve your goals. 

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If you're trying to pay off debt and rebuild your credit, then connecting with an independent adviser is an excellent first step. An adviser will discuss your specific financial goals and help get you started on the right path.

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