How to Rebuild Credit in 6 Steps
Your credit score is a sensitive number—three digits that can move up or down on any given day depending on how the information in your credit report changes. If you’re unsure of how to rebuild credit – have no fear, we can help guide you through this normally dreadful process. But, we’ll make it easy for you
If you need to borrow money but have poor credit it can feel like an eternity before the number is acceptable to lenders. With positive changes in your credit managing habits, you can see credit score improvements occur in as little as one month.
How long does it take to clear a bad credit history?
Developing new, more responsible habits is the first step toward improving your credit, but your previous bad credit history won’t just disappear overnight. Late payments, repossessions, foreclosures, charged-off accounts, and civil claims judgments all remain on your credit report for seven years. Chapter 13 bankruptcies also stay on your report for seven years, while Chapter 7 bankruptcies remain on your report for 10 years.
The good news is that it doesn’t take too long to build up your credit history if you’re starting from zero. According to Experian, one of the major credit bureaus, it takes between three and six months of regular credit activity for your file to become thick enough that a credit score can be calculated.
Before you get started, take advantage of your annual free credit report. You’re allowed one pull from each of the three major reporting bureaus, Equifax, TransUnion, and Experian, each year.
Keep in mind that your credit report does not include your FICO or VantageScore credit scores. However, you can take advantage of various free credit monitoring services to see both your credit score and credit reports. In addition, many credit cards now offer free FICO score tracking.
Once you have your report, check every bit of information for accuracy. Highlight the areas of missed payments, derogatory accounts, misspelled names, and addresses, etc. and get to work!
Ways to Start Rebuilding Your Credit
1) Become an authorized user on a family member’s credit card.
Your parent, spouse, or sibling can call their credit card company and ask to add you as an authorized user on a card. This will work only if your family member’s account is in good standing.
Once the request is approved, you will receive a credit card linked to the account that you can begin to use.
It’s important to note that your debts on the card cannot be paid directly by you. Instead, your family member — the main account holder — is responsible for paying the bills. As long as this person has a good credit history and doesn’t miss payments, your relative’s good credit standing will positively impact your credit score.
Once your score starts looking sharper, you should apply for your own credit card and keep building on your good foundation.
2) Pay down your balance
30% of your FICO score is based on the amount you owe. However, it’s not simply how much you owe that’s important. It’s how much you owe compared with how much credit you have, a ratio known as your credit utilization rate.
For example, if you have a $5,000 credit limit and a $2,500 balance, your credit utilization is 50%. If you’ve maxed out that $5,000 limit, your utilization is 100%.
There are many theories on the ideal credit utilization rate, but Experian suggests it’s best to have a rate of less than 30%. In other words, you should never have more than $3,000 charged at any time if you have a $10,000 limit. If your credit utilization rate is high, paying down your balances is a quick way to lower that rate and thus boost your score.
3) Open a secured credit card
A secured card requires you to make a deposit upfront to open a line of credit. The bank or credit card company holds this deposit in case of a missed payment by the borrower. For example, a card that requires a $300 deposit will typically offer a $300 credit limit. As long as you make on-time payments every month, you will eventually — usually after eight to 12 months — get your deposit back, at which time you can choose to close your account and open an unsecured card.
The positive activity on your card will be reported to the credit bureaus and help improve your credit score.
One drawback to a secured credit card is the addition of fees to the deposit. This might include application, processing, and annual fees just to have a card. Also, the interest rate is often higher on a secured card. Keep in mind, paying off the balance each month helps you avoid paying high finance charges.
All in all having a secured credit card is worth the extra fees and rules needed to build credit. Most secured credit cards after a few months will show a positive outcome and a higher credit score!
4) Always Make Payments on Time
According to FICO, 35% of your credit score calculation consists of your payment history. This means that it is imperative that you always pay your bills on or before the due date, and never miss making a payment.
Not only do late payments reflect negatively on your credit, but they can also create negative marks that negate all of the steps you’ve taken to build a positive credit history. To ensure that you always pay on time, write due dates in your calendar, have your creditors send bill payment due to alerts, or, better yet, automate your payments.
5) Keep your credit accounts open
Not only do you need a credit card, but it can actually benefit your credit score to keep those cards open – provided you continue to make your payments, of course.
The amount of time you have had credit for is a substantial percentage of what goes into your credit score; 15%, to be specific. The longer you have credit accounts and are successfully making payments on them, the more dependable you seem, and the better your reputation will be with regards to your finances. So the simple act of having these existing accounts for an extended period of time can help you build better credit.
Closing your older accounts, on the other hand, can shorten the credit history of your current accounts. That can result in a temporary downturn in your credit score that you will have to build back up. So don’t risk it!
6) Don’t inquire too much
When you submit an application for a credit card, the credit card issuers generally perform a hard inquiry – also known as a hard pull. The term ‘hard inquiry’ refers to when a potential lender is reviewing your credit because you’ve applied to open a line of credit with them. Any hard inquiry, even one where you are approved for the card, has the possibility of lowering your credit score. It is unlikely to cause a lasting, negative impact to your score as long as you limit the number of credit cards (or loans) you apply for in a short time-frame
According to FICO, single inquiries don’t usually have a huge impact, but the story may change if there are multiple back-to-back inquiries. It suggests to lenders that you may be a risky borrower, which could lower your credit score.
How often does my credit update?
Once you have opened a credit card or installment loan, it takes approximately 30-45 days for the creditor to report the account to Experian. Typically, an account is reported at the end of the first billing cycle after your first payment is due.
The good news is that it doesn’t take too long to buildup a credit history. According to Experian, it takes between three and six months of regular credit activity for your file to become thick enough that a credit score can be calculated. Building credit is a lot like losing weight. There’s a lot more to it than just flipping a switch or pressing a button.
The key takeaway
Building your credit from scratch isn’t an overnight process. But those who are patient, and handle their credit responsibly, will reap the rewards of their hard work.
The key is to take it slow, make on-time payments, keep your credit utilization ratio in check, and diversify your credit profile.