Editorial Policy

5 steps to repairing bad credit

Dawn Papandrea

March 5, 2015

Facing down your credit mistakes can be frightening, but it's not a hopeless battle.

“There are ways to get back to a sound financial footing even after some missteps as it relates to credit,” says Randy Hopper, vice president of credit cards for Navy Federal Credit Union. Just understand that it's going to take discipline, planning and, most likely, lots of time.

A good credit score means better loan rates, insurance premiums and even apartments. A bad score? These things could end up costing you cost you much, much more.

Here's what you need to know about escaping the pit of credit despair.

How long will it take?

Rebuilding your credit score is like climbing up a mountain, says Liz Weston, personal finance columnist and author of “Your Credit Score.” “The higher up you were when you fell, the longer it's going to take you to get back up there.”

Hopper agrees, saying that the amount of time it will take really depends on the nature of the bad credit performance in your file. “It may take years of good performance to balance out the bad,” he says.

That's right, he said “years.” Don't believe any expert or product that promises instant, overnight credit score rebuilding — it's just not possible. That being said, it's never too late to start overwriting your mistakes with positive credit activity and get on the road to recovery.

The credit score climb

So what's a good credit score benchmark? Weston says that a 680 FICO score is a good target after a period of bad credit since that's the level at which the majority of lenders will consider working with you and offering terms and rates that are better than subprime. For some perspective, the average national FICO score was 692 as of April 2014, according to FICO.

Of course, the gold standard of credit scores is north of 700, but one step at a time. Here are some of the things you can do to begin your credit ascent.

Step 1: Pull your credit reports

“It's funny how many people resist this step, but you want to know what's going on with your credit,” says Weston. She recommends going a step further and getting a credit score, too. That way, you get a better idea of what you need to do to improve.

Check one of your credit reports for free at AnnualCreditReport.com; check your credit score for about $20 at MyFICO.com.

First and foremost, if you see any errors, get them corrected since even the smallest mistake, such as a creditor reporting a late payment that you actually paid on time, could bring down your score.

Step 2: Be strategic in your debt payoff

If you have outstanding balances or old collections, it's time to  make amends. “If you have a balance on a credit card and an old collection, in terms of credit score, paying off the card first is better,” Weston says.

“If you have a balance on a credit card and an old collection, in terms of credit score, paying off the card first is better.”
–Liz Weston, personal finance columnist

For things such as federal student loans, there are a several options available for getting those loans out of default and managing repayment. (Head to the Department of Education website for details.)

As for working directly with your card issuers, the level of help they might offer is all over the map, says Weston. “If you already have an overdue balance with them, call and see what your options are. However, don't commit to anything or try to deal with your debt without making sure you cover your basic financial needs first,” she says. In other words, don't get talked into paying off a balance with your electric bill money.

Also, no matter what deals you make with card issuers or creditors, get the agreement in writing. Making a visit to a nonprofit credit counselor can help, too. A credit counselor can help you sort through your debts and your budget to create a clearer picture of the steps you need to take to become debt-free. Choose a credit counseling agency affiliated with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies.

Step 3: Get a secured credit card

Once you've reconciled any accounts that were in poor standing or at least put together a manageable payment plan, you have to prove that you are ready to use credit responsibly again. Your options will be limited since most lenders won't approve your application, but you will likely be able to qualify for a secured card.

A secured card requires you to put a deposit down as collateral and gives you a small credit line to work with — usually a few hundred dollars. Hopper says you'll want to start budgeting to put money aside for your secured card deposit, while taking the time to research your options. “A lot of secured products carry fees and high-interest rates. When you're rebuilding your credit, you should try to do so as affordably as possible, and there are many options available to consumers,” he says.

Whichever card you choose and qualify for, the key is to use it lightly and responsibly, says Weston. “This credit card isn't for carrying balances, and it isn't for paying stuff off over time. It's solely about building credit.”

Two of the major components of your FICO credit score, the dominant scoring model, are paying your bills on time and your debt utilization, which is the amount of available credit that you are using. “Many consumers don't necessarily have a grasp on managing their credit ratio. Even a low limit on a secured card should maintain a debt-to-credit ratio below 30 percent,” says Hopper. That means if you have a $300 limit on your secured card, your balance shouldn't go above $90. Ideally, pay in full each month so that your utilization ratio is as close to $0 as possible. Hopper suggests using your secured card for a specific monthly expense, such as a membership fee. That way, you can control exactly what you're putting on the card and make sure you have the funds to pay it right off.

“Many consumers don't necessarily have a grasp on managing their credit ratio. Even a low limit on a secured card should maintain a debt-to-credit ratio below 30 percent.”
–Randy Hopper, Navy Federal Credit Union

Once you've managed a secured card for at least a year with on-time payments, if you've had some credit score improvement, you can look into qualifying for a non-secured credit.

Step 4: Manage a mix of credit

Another component of your FICO credit score is your credit mix. That means not only is it important to show that you can manage revolving debt such as credit cards, but how you handle installment debt, such as an auto loan, will affect your credit file, too.

“The balance on an installment loan doesn't hurt your credit score,” explains Weston, “while the more revolving credit you're using, the more it hurts your score.”

While you shouldn't go out and start applying for loans just for your credit score's sake, if you do end up needing a small personal loan or auto loan, those products — when paid on time consistently — can be good for your credit health.

Step 5: Stay the course

As you make your way back toward a healthier credit file, do your best not to falter.

Remember, even if you've fallen on hard times and lost access to the privilege of using credit temporarily, if you stick to a credit improvement plan, you can redeem yourself and get back into the good credit score zone.