Editorial Policy

How to Rebuild Credit After Hardship

default author image

By Eva Norlyk Smith, Ph.D.
May 5, 2011

People end up with bad credit for many reasons: long-term unemployment, investment decisions that went bad, medical expenses or other unexpected life events.

During the Great Recession, in particular, millions of American households found themselves underwater — and many of these households are still trying to put the pieces of their financial life back together.

When people develop bad credit, a common reaction is to get off the credit horse entirely and simply stop using credit, says Melinda Opperman, Senior Vice President of Community Outreach and Industry Relations for Springboard, a nonprofit credit counseling agency. But that’s exactly what you don’t want to do.

“To rebuild credit, it’s essential to use credit,” says Opperman. “And you have to rebuild that credit score, because your credit score determines your financial success going forward in so many ways.”

If you’ve been hit with long-term unemployment or other financial hardship, here are four steps to get back on the credit horse and rebuild your credit:

1. Create a budget and a debt repayment plan.
There is no way around it. To get out of debt, you will have to put yourself on a budget and create a plan for how much you will pay off at a time. Many people with financial problems resort to paying only the minimum amount due on their credit cards. However, paying only the minimum amount is a band-aid solution that helps you ignore the real problem — and it quickly lands you deeper into credit card debt.

To force yourself to address your debt problem, look for ways to pay down your credit card debt each month. Freeing up money to make debt payments means prioritizing debt payments over other, more desirable purchases and expenses, and that is rarely fun. Unfortunately, to get out of hardship, you have to go through hardship, so be ruthless in your spending priorities.

2. Pay off high-interest credit card debt first.
Target credit card debt with the highest interest rate first. If you have credit card debt with default penalty interest, call the card issuer and try to negotiate a better rate. Many card issuers will go a long way to work with cardholders in order to avoid having them default on their credit card debt.

3. Maximize the positives.
If you have defaulted on credit card debt or other loans, adding positive actions, such as regular payments on other credit accounts, will counteract the negative marks over time.

“You’re given points on your credit score for positive credit behaviors and points are taken away for negative credit behaviors,” explains Opperman. “It’s very important to establish positives to offset any negatives you may have. Even if a few accounts can be kept current, that will offset some of the negative effects and will help reestablish credit.”

To add positives to your credit history, pay all of your credit card bills on time and pay more than the minimum amount due. If your credit card accounts have been closed because of past defaults, consider taking out a secured credit card or other credit card for bad credit to reestablish a payment history.

4. Consider credit counseling.
Getting rid of debt and rebuilding credit is a long process. That’s why you might want to consider getting outside help — particularly if you’re dealing with creditors. Having an experienced coach to guide you through the process can make a big difference.

A good credit counselor will not just help you develop a budget and a debt repayment plan; he or she may also help you negotiate better terms on loans or lower rates on credit card debt.

Unlike debt settlement programs, which are fraught with scams, there are many legitimate nonprofit agencies that provide credit counseling. To find a credit counseling agency, Mike Sullivan, Director of Education for Take Charge America, recommends looking for a nonprofit agency that is a member of either the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies, two leading national associations of credit counseling agencies.

Another option is to check the Better Business Bureau website for a local credit counseling agency with a great rating. An initial phone call to an agency is usually enough to let you know if you’re in the right hands.

“You should get real help and real advice and not get pushed into doing anything that will cost you money,” says Sullivan. “If you call someone for help and the first thing they do is to get you to send money, then hang up.”