iEconomic cycles govern our personal and financial lives. Life’s uncertainties—job loss, emergencies, foreclosures, bankruptcies—can severely damage credit.
While financial crises can be daunting, they are not the end of the road. With a commitment to bouncing back, discipline, careful planning, concrete goals, and strategic choices, it is possible to recover from financial troubles and rebuild your credit status.
Bad credit carries numerous disadvantages. It makes it challenging to qualify for credit cards and loans. It puts you at a disadvantage in the job market, and It can complicate simple life decisions like renting a place at an ideal location. Moreover, interest rates, insurance premiums, and security deposits could all increase.
Today, about 33 percent of American adults rate fair to poor FICO scores, reflecting how widespread the problem of poor credit is. Bankruptcy will likely exacerbate any credit issues, causing an initial drop of about 100 to 200 points in your credit score.
Getting on top of your financial woes and rebuilding credit as soon as possible is vital to financial recovery. Here, we discuss rebuilding your financial health from scratch and improving your credit score for a sustainable future.
Step 1: Assess the Damage to Your Accounts
Determine the starting point by assessing your financial situation. Examine debts, expenses, assets, and income.
Review liabilities
Assess all your current liabilities. Include interest rates, minimum credit card payments, and outstanding balances in the data. Rank your debts, starting with the ones with the highest interest rates. Explore how to pay for the high-interest debts first, and explore debt consolidation or restructuring options.
Check your credit report
You must be familiar with your credit report. You can access a free copy of your comprehensive credit report through the major credit bureaus: TransUnion, Equifax, and Experian. These three bureaus are the largest providers of consumer credit reports to lenders in the US. They also provide such reports to employers, insurance providers, and companies that need credit information to help assess risk.
Armed with this new knowledge, you can easily identify and report discrepancies, inaccurate records, and fraudulent activities. After weeding out all errors in your credit report, you can use the information to develop a strategic plan to rebuild your finances.
When you understand the components of your credit score, you can find out what’s been bringing it down. With this review, you can also monitor and confirm whether your bankruptcy has been removed from your report as soon as possible. In the US, it’s after ten years under a Chapter 7 and seven years after a Chapter 13 bankruptcy.
Step 2: Develop a Strategy for Financial Recovery
Once you’ve assessed your post-crisis finances, take proactive steps. Develop a comprehensive financial recovery plan encompassing realistic goals, debt repayment, emergency savings, and credit repair.
Define your financial goals
Every financial strategy begins with objectives. Define your financial strategies by establishing short, intermediate, and long-term goals. These objectives may involve debt clearance, emergency fund creation, retirement savings, vacation planning, business initiation, home purchase, or overall financial security enhancement.
They can also involve investing, growth, and having room for the finer things in life. More importantly, they should include rebuilding your credit score if you just came from bankruptcy or another financial crisis.
Develop a plan for debt repayment
Once you’ve identified your goals, you must develop a plan to repay debt. It would be best to prioritize paying your debts according to outstanding balances and interest rates. However, you might prefer to see things from the perspective of either the debt snowball or debt avalanche.
The debt snowball strategy encourages you to pay off the smaller debts first, building momentum toward paying more significant obligations. The debt avalanche technique accelerates repayment by prioritizing high-interest debts and working your way down. In each of these methods, you aim to build momentum towards knocking off debts based on what incentivizes you and what your financial situation affords.
Save for an emergency fund
When attempting to rebuild credit after a financial crisis, you must never forget to allocate money towards emergency funds. Even though you are paying off your debts, you need an emergency fund to ensure financial stability. You must have about three to six months’ living expenses in an untouched separate account.
Why is an emergency fund necessary? It provides a financial cushion for unexpected events, preventing you from getting further into debt during future crises.
You also need to know where to save your emergency fund. A few good options would be a high-interest-rate savings account via an online bank and a high-yield savings account. Ensure your bank or credit union insures deposits through the NCUSIF or FDIC.
Develop a strategy to reestablish good credit
Rebuilding credit is crucial to getting back to financial health. There are faster ways to improve your credit, but each requires discipline, determination, and focus. Below, you will find concrete steps to start fixing your credit even as you are still dealing with the after-effects of loss or bankruptcy.
How To Rebuild Credit After a Downturn
Now that you have a basic idea of the framework for credit recovery, let’s get into the details. After experiencing a bankruptcy or severe financial slump, you could find it challenging to demonstrate to lenders of future financial capability.
After assessing your starting point and becoming fully aware of your credit situation, you must immediately work on understanding how to increase your credit score. You can improve your score in the following ways:
Pay on time
Changing your financial habits means one crucial thing: first, pay your bills and existing lines of credit on time. If you can manage the minimum, it’s fine in the short term. If you cannot make the minimum, you must contact your creditor to make arrangements that will help you temporarily alleviate your debt burden.
Paying on time is crucial because payment history is the top factor influencing your credit score. As much as thirty-five percent (35%) of your credit score depends on your payment history. A single missed payment can dent your report.
Hence, in the process of rebuilding your credit, you cannot afford a late payment. Your late payment history can remain on your credit report for 7 to 7.5 years.
Regarding bills that have gone to collections status, it may be better to prioritize those wherein you still maintain an open account. While collectors might be on your back, open accounts should be your highest priority.
Dispute errors on your credit report
After your initial phase of data gathering, you should be able to point out errors, if there are any. Addressing this simple step could swiftly enhance your credit. Any mistake on your credit report could be contributing to lowering your score.
Take advantage of your entitlement to free reports from the three major credit bureaus. Use them to uncover errors like falsely recorded late payments, outdated negative information, and instances of credit activity not associated with you, such as fraud.
After identifying these mistakes, dispute them immediately. The process could prove tedious and involve several follow-ups. However, it is worthwhile, especially when recovering your credit score.
Reduce credit card use
You will likely stumble into the same habits that led you into a financial crisis. Thus, it makes sense to stop falling into those habits immediately or avoid them altogether. Reduce the temptation to spend and prevent yourself from slipping into more debt.
Keep credit card balances low
Your credit card balance makes up 30 percent of your FICO score. After bankruptcy, focusing on this element is essential to helping you rebuild credit quickly.
Consider a secured credit card
To secure a credit card, you must provide an upfront cash deposit as collateral. While you reduce credit card use, you can still utilize secured credit cards strategically as part of your plan to repair your trustworthiness with lenders.
When you use a secured credit card, you borrow against your refundable security deposit. This option demonstrates to lenders your willingness to show responsible credit behavior and makes you eligible for a regular card with better terms. They are likely to come with high-interest rates, though.
The good news is some secured cards let you move on or graduate to an unsecured card after demonstrating consistent and timely payments. Research in this case is critical, too. It would help if you looked for a provider that offers pre-qualification before they do a hard credit check, which could further damage your credit score.
Lower your credit utilization
This item is related to reducing credit card use. Apart from refraining from using credit cards per se, you need to be mindful of the percentage of your balance versus your total credit limit. Credit utilization is the percentage of credit you’re using.
Experts recommend utilizing no greater than 30 percent of your credit card’s spending limit. The lower your present credit utilization, the better your credit score. Review the credit utilization of all your credit cards. Work on lowering the highest ones first.
When you achieve a lower balance, your credit card issuer will report it, positively impacting your score. Past credit utilization levels will not hurt your credit score once you’ve managed to bring your balances down.
Consider becoming an “authorized user”
In credit card terminology, an authorized user is a person added to a primary cardholder’s account. While the credit card company issues a card with the authorized user’s name, the primary user is the legally responsible party.
By becoming an authorized user, you piggyback on another person’s credit card account. This method is one way to improve your credit quickly. In cases where the primary user boasts a substantial credit limit and an extensive history of punctual payments, and the authorized user maintains an unblemished credit report without recent issues, this arrangement proves mutually advantageous.
You can arrange to do this in several ways. The primary user and authorized user should agree on whether the authorized user can use the card for purchases or will only be listed as an authorized user. Either way, the effect is the same on the authorized user’s credit. It’s also crucial that both parties agree on a payment arrangement beforehand should the authorized user utilize the card for purchases.
Becoming an authorized user will help lower your credit utilization by accessing more available credit. Because credit utilization is a significant factor in credit scoring, getting authorized user status can help improve your credit score quickly. Remember that credit utilization is only second to payment history regarding the impact on your credit score.
To illustrate the effect of this strategy, consider a credit card with a $1,000 limit. Utilizing 30% of this means having a balance of $300. That’s the maximum ideal credit limit. However, if you are an authorized user on a lightly used card with a high limit—say, $15,000—you could immediately drop your overall credit utilization, possibly improving your credit score.
Have someone co-sign your credit card or loan
If you’re struggling with credit, you can ask a family member to co-sign your credit card or loan. While this benefits you, remember you are asking another person to take responsibility for your debts and put their credit reputation at risk in case you don’t pay.
Moreover, the co-signer could suffer the consequences of the arrangement. They could be declined if they apply for more credit later, as the account will be included in their financial assessment. Thus, only consider this option if you are confident of repaying your debt. The inability to do so will hurt your co-signer’s reputation and credit score, not to mention your friendship or relationship.
Consider applying for a credit-builder loan
A credit-builder loan helps build your credit without applying for a traditional loan. Borrowers without a credit history or trying to rebuild their scores can use credit-builder loans to demonstrate the ability to make on-time payments.
A credit-builder loan—a personal loan—helps borrowers improve their credit scores. It is the opposite of a traditional loan, in which a lender disburses a lump sum to the borrower at the beginning of the loan term.
Instead of doing this, a credit-builder loan holds money in a special savings account or certificate of deposit (also called a CD) in the borrower’s name until you pay the loan in full.
In a credit-builder loan, the borrower doesn’t receive the money upfront. Instead, the borrower makes fixed monthly payments against the loan principal. In addition, as credit builder loans charge an APR or annual percentage rate despite not giving the money upfront, the borrower also includes interest and finance charges in the monthly payments. Interest in these types of loans typically ranges from 6 to 16 percent.
The loan term can extend anywhere between 6 to 24 months. Within this period, the lender reports the borrower’s payment history to credit-reporting agencies. The process of reporting can help build positive credit.
The loans with more significant credit limits—granting they are repaid on time—have a more considerable effect on credit scores. Larger credit limits and timely payments demonstrate a borrower’s ability to manage more debt. Payments made on time increase credit scores. Conversely, late payments can damage credit scores.
The funds are released when the borrower completes the payments and the loan term ends. Sometimes, they include a part of the interest.
Credit-builder loans are considered lower risk than regular personal loans because lenders don’t need to disperse funds at the beginning of the loan term. Therefore, how such loans are structured makes it easier for borrowers—even those with bad credit—to access funds.
Get credit for rent payments
You can use your rent and utility payments to improve your credit score. You can use rent reporting services to factor in your on-time payments to your credit report. Availing of the service doesn’t mean, however, that rent payments are considered in every scoring model.
Note that the impact of such payments on your credit score is variable. FICO 8 doesn’t consider them, but VantageScores does, for example.
Even if you can’t always use rent reporting services, your report will reflect your rent records and a prospective creditor will have access to them. A history of long-term and consistent payments will reflect positively.
The time commitment for this strategy is low, and it could boost your score instantly. Note, however, that the rent reporting aspect varies with the service used. Some services offer instant “lookbacks” of your past two-year record. Building your history of timely payments may take longer without such a record reflected on your report as a lookback.
Pay off collections accounts
Paying off a collections account removes the threat of lawsuits over your debt. In addition, you could persuade the collection agency to stop reporting the debt once you’ve paid it in full. You could also remove collections accounts from your credit reports if they are too old to be listed or are found to be inaccurate.
The impact of this strategy on your credit score varies. When your account is in collections, this is a serious negative mark on your report. Thus, a collector who agrees to freeze reporting your account will help tremendously.
Should the collector keep reporting the account, the impact of your actions will depend on the credit scoring model employed. The FICO8 model accounts for paid collections. However, VantageScores and the more recent FICO models tend to ignore paid-off collections on your record.
If successful, this approach could work relatively quickly on your credit score. The credit scoring models that ignore paid collections will reflect the benefit sooner. The process could take over a few months on the ones that reflect them or when there are disputes on a collection account or a request for a goodwill deletion.
Maintain a steady source of income
As you rebuild your financial profile, you want to show lenders that you can maintain a steady and reliable income stream through a job or a business. Lenders take your employment history into account when reviewing applications. You also want to show lenders that you can pay back debts. A record of job hopping or employment gaps can make you appear like a risk.
Establish positive financial habits
It would help if you disciplined yourself to practice positive financial habits to help you improve your financial health and accomplish your goals. It’s all part of adjusting to a new reality.
If you’ve already filed for Chapter 7 bankruptcy, you would have needed to sell off assets to help pay off your debts. The resulting shift in lifestyle—fewer possessions and reduced wealth—will require you to adapt your mindset and lead a simpler life.
It helps to see bankruptcy as a fresh start and a chance to be more financially savvy. You must follow a strict budget, and your budgeting method needs to include a plan to pay off all your balances.
Consider setting up auto payments on your accounts to help you keep track of your expenses and stick to a schedule. Frugality, budgeting, and financial discipline will help you weather the storm and develop positive financial habits that will go a long way in establishing a debt-free future.
To Rebuild Credit, Take Consistent Action
Bouncing back from a financial crisis or bankruptcy can be difficult. The journey requires resilience, dedication, discipline, and commitment. With the proper steps, however, it is not impossible.
Repairing your credit is crucial to financial recovery; you must be methodical. Concrete and practical measures can get you closer to improving your financial state, such as making on-time payments, reducing credit card use and credit utilization, paying off collections accounts, and applying for programs that help you rebuild lender trust.
By being diligent and methodical about credit rebuilding, your credit missteps will eventually recede into the past. The recovery time will depend on your credit score and recent mishaps. Some significant events like bankruptcy can linger on your record for up to ten years.
However, none of your mistakes should dissuade you from acting fast and consistently. You should begin to see improvement as soon as you accumulate positive credit information and work on countering the negatives.
When you come to terms with the extent of the problem, develop a strategic plan, and act on proven ways to improve your credit standing, you can emerge from the experience with your debts paid and sharper financial insight than before.
