Having bad credit doesn’t make you a bad person. It can, however, make it far more difficult to become a wealthy person.
There are many reasons people run into credit difficulties: job loss, accidents, and other medical problems, among other unforeseen expenses. No matter what the cause, there’s a process to effectively repair your credit. It won’t repair itself. It will take some work, but the payoff is enormous.
Substandard credit makes it costlier and more difficult to borrow money. While it’s possible to live a life without credit, it’s not generally the best way to go.
Credit allows us to accomplish many things sooner than we would be able to without it. And sometimes that can save us a lot of money. For example, many people could never save enough to purchase a home outright. But most people can accumulate enough for a down payment. Getting a mortgage allows you to purchase a home you might never be able to save for — especially in hotter real estate markets.
No matter how much damage your credit has incurred, it can be improved. Usually, while the process takes time, it's otherwise pretty straightforward. Here’s how to repair credit in seven steps.
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Step 1: Accept Responsibility
The first step to repairing your credit is to acknowledge that it’s your credit. You’re the only one who can turn this around.
There may have been circumstances beyond your control this time, but next time you can have a better contingency plan.
Or you may have made some mistakes. Recognize that mistakes are something you can learn from and not be something you have to repeat.
Credit and credit scores are manageable. You can put a plan in place, work the plan, and build credit that will enable you to accomplish your financial goals. Only you can make it happen.
Step 2: Examine Your Credit Report
You're entitled to a free copy of your credit report from each of the three major credit bureaus once every 12 months. Note that this is not once every year. You have to wait one year from the last time you received your free report from that particular bureau.
You could get one immediately from each of the three bureaus. Or you can get one, then in four months get one from another bureau, four months later get one from the third. That will allow you a free credit report every four months.
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Getting them all at once allows you to make sure that there aren’t mistakes on one that hasn’t carried over to the others. Spreading them out allows you to review your credit every four months without incurring a cost for a report. Either way is fine. I prefer the spread-out method, but pick whichever makes you happy.
Carefully check your report for errors and dispute any inaccuracies you find. For example, you might find late payments when you actually paid on time. Or you might find accounts that aren’t yours.
When you dispute an item on your credit report, the company that reported the information has 30 days to substantiate it. Otherwise, it has to be removed from your report. Banks and credit card companies tend to be quite good at this. You probably won’t win disputing things that are accurate.
Step 3: Establish a Realistic Budget
You’re probably like, Hey, what’s that doing here in an article about credit repair? But it’s extremely important.
A budget is a plan for how to use your money. You need to figure out how much you can realistically afford to pay each month toward your debt. There are a number of apps or other programs you can use. No matter what form of budget you choose, you need to come up with a monthly amount that you can consistently apply toward paying down any outstanding debt.
Step 4: Establish a Payment Plan
You generally want to pay off your highest-interest-rate debts first. But many people find it easier to pay off small balances immediately and get them out of the way.
From the standpoint of rebuilding your credit, you do want to clean up as many of the small items as you can right away. There’s no reason to keep accounts with $50 or $100 balances hanging out for longer than necessary. Clean them up. Then focus on the real problem accounts, working on the ones with the highest interest rates first.
You may need to contact some of your lenders to establish a payment plan. Sometimes the bills are just more than your paycheck allows you to pay. Be realistic and negotiate the best you can.
Beware of companies looking for you to make a “good faith” payment before they’re willing to negotiate.
Negative items stay on your credit report for seven years after the last activity. Often, the “good faith” payment that the company is looking for is really just to increase their leverage.
For example, you might not have used an account or made a payment in five years. If you do nothing, it will come off of your credit report in two years. You will still owe the money, but it won’t appear on your credit report. If you make a good-faith payment, the clock goes back to seven years before the information will come off of your report. And it will be there whether you manage to negotiate a payment plan or not.
Step 5: New Accounts and Higher Limits
The largest single factor driving your credit score is making payments on time. You need to use credit to build credit. But use it responsibly.
If your credit is in rough shape, you may need to begin with a secured credit card. Others may need a card designed for those with credit troubles. Either way, shop carefully for the best rates and lowest fees. And only charge a little each month and then pay it off.
The second largest factor driving your credit score is utilization, or the ratio of outstanding balances to available credit. The lower this number is, the better. You can improve (lower) your utilization ratio by paying down debt or getting more credit. If you can get higher limits, this will improve your credit score immediately.
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Step 6: Pay Down Accounts
Making consistent, timely payments and reducing your balances will improve your credit. It can take a long time to pay down big balances, but each payment helps. And don’t miss any of them. The objective is to build good credit, then great credit, and then keep it. It’s not an overnight process.
Step 7: Review and Monitor
Once you’re on the road to improved credit, you’ll want to keep checking your progress and making sure no new errors appear on your credit reports. Take advantage of your free reports from each of the three major bureaus and keep close tabs on the information, paying particular attention to any possible errors that could hurt your credit score.
How to Repair Credit: The Long Game
Building and maintaining good credit is an ongoing process. This is not a one-time, done-that scenario. Working your credit becomes a part of your financial independence process.
As part of that process, you should also put thought into maintaining credit and otherwise preparing yourself for life’s surprises. People with solid emergency funds are less likely to get into credit difficulties because of one of these surprises. They're set up to pay their bills, even in the event of a layoff or sudden job loss; they’re prepared to deal with an unexpected car repair or unplanned medical expense.
Being prepared puts you in a position to be able to use credit to your advantage. If you’ve taken care of the rest of your financial affairs, then once you build good credit, there’s no reason to ever had bad credit again.
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