How to Rebuild Credit

Having good credit is a must have to manage an easy financial lifestyle.  If you do not have good credit, obtaining financing for the simplest things can turn out to problematic. There are those who feel that they don’t need credit but in our credit-driven society, having access to credit can prove to be invaluable.  Many young adults destroy their credit within the first few years of adulthood.  Perhaps it is because no one taught them the proper ways to manage credit.  There are a myriad of issues that can cause a person to not have good credit. If you fall into this category, you should not be ashamed. We all make mistakes and let’s face it, some are better at managing money than others. You can only rebuild credit after you have properly managed the debt that you already have defaulted upon.  You must develop a plan to repay your debt whether that includes budgeting, credit counseling, or a last-resort bankruptcy filing. Rebuilding credit is when you have lowered all of your debts and you are in a good position to begin reestablishing good credit habits.

What is Credit Rebuilding?

Credit rebuilding is when you begin implementing new habits in managing credit and debt.  In order to properly rebuild credit, you need to know how credit works.  You need to know what affects your credit score and you also need to know how much credit that you can comfortably juggle without placing yourself at risk.

How to Start

Before you begin establishing new credit managing behaviors, you must first take a look at your financial health and determine if you are financially able to take on credit.  Credit has to almost always be backed by capital.  Capital is wealth in the form of cash or other assets.  If you want to determine how you fair when it comes to capital, you must assess your net worth.  Where do you currently stand as it concerns the amount of debt you have compared to the amount of capital that you have.  Take a debt to net worth assessment to discover where you stand financially. This is a simple formula: Assets – Liabilities = Net Worth.  The older you become, your net worth should go from negative to positive as your earning power converts into more asset building and liability reduction.

Finding out what your debt to net worth is will allow you to see the overall picture of how much debt you are in and this should lead you to prioritize whether you should take on more debt or focus on paying down the debt you already have. Most young people will have a negative net worth due to student loans, a car, and eventually the initial purchase of a house.  Determine how much debt is taking away from your capital is step one.  However, there are some people who may have negative net worth but still are able to manage additional debt due to their debt to income ratio. Calculate your Debt to Income ratio now.  The debt to income ratio is what lenders will evaluate when deciding to extend new credit to you.  Keep this in mind.  The debt to income ratio is for creditors to evaluate you and the debt to net worth ratio is for you to evaluate yourself. Both of these ratios will determine your ability to pay back credit.

Once you’ve determined if your debt situation is resolved and you are out of debt or have a significantly low debt to income ratio, then you can consider rebuilding your credit score if it has been damaged due to past mistakes.

Tools to Rebuild Credit

Your credit report will evaluate how well you manage credit and how well you manage paying back credit on time over a period of time.  Your credit activity is measured and some factors weigh more than others.  See below:

Credit Score Percentages

For a detailed explanation of the role each component of your credit plays, click here.

You can start rebuilding your credit by starting with a credit card account also known as a revolving account or try a personal loan. You should aim to have one of each for a healthy credit mix.  Remember, when rebuilding, it is not your goal to obtain large amounts of credit, but yet obtain enough credit to be able to establish a new pattern for creditors to look at. If you open a credit card, you must keep your credit utilization under 30% at all times in order to maximize your rebuild efforts. credit utilization is weighed under the “How much you owe” section of the pie chart above.  That is almost as important as payment history so please take that into heavy consideration.  If you max out your credit cards, then you tell creditors that you do not know how to properly manage credit, it will lower your score, and hurt you as you rebuild credit.

Ways Around the Dreaded No

Obtaining new credit when you are trying to rebuild credit can seem almost impossible when your credit is bad.  Yes, there are cards out there that will open accounts for bad credit profiles but they usually carry morbidly high interest rates with unnecessary annual fees with little to no benefits. If you are going to pay an annual fee on a credit card, pay it on a card like American Express or a prime card that offers rewards and cash back incentives.

If you see that you are being turned down for traditional credit with reputable credit card companies or are not able to secure a small installment loan then there are ways to get around the denials.

You can use your own capital to secure lines of credit in revolving and installment forms.  This type of credit is called secured credit.  Secured credit is when a creditor allows you to deposit money with them and they offer you a line of credit in exchange.  The line of credit is usually equal to the amount of your deposit.  You can do this with both credit cards and personal loans.  Here are two secured credit cards that I would recommend beginning with.

DiscoverIt Secured Card

Discover offers a secured card that will allow you to provide a deposit in exchange for credit.  I recommend this card because Discover is considered a major player in the credit game and using this card will provide great additions to your credit rebuilding process. While having a credit card is beneficial, some cards carry much heavier weight than others and will grow your credit score much faster. Discover will convert your account to a traditional unsecured account after 7 months of good history.  What do you have to lose?  Apply here.credit

Primor Secured Card by Green Dot

I used this card when rebuilding my credit from the damage I experienced during the recession.  It was once managed by Berkshire bank but recently changed hands to Green Dot. It is not a major card but I’ve included this as a good choice because it offers a very low interest rate, even lower than what American Express offers to some of their very qualified clients. Their website offers 13.99% but once you’ve opened the card, they will offer you 9.99%.  This card is fully secured and will require a cash deposit in exchange for credit.  They will never convert the card to an unsecured card so keep that in mind.  Your credit line will always be backed by your deposit. There is no annual fee.  Apply here.

Some secured cards still require you to have a minimum credit score of about 530 or better with a relatively low amount of debt.  This is why the conversation about debt to income ratio and debt to net worth was important.  Creditors understand that even if you are a high risk, they still will not lend to someone who is bankrupt even if it is a secured product.

Secured Installment Loans

If you are seeking a secured installment line of credit, you can go a very popular route called Certificate of Deposit.  Visit your bank to obtain a certificate of deposit.  The process involves you taking your own capital and have them deposit it in an interest-bearing account.  You should be able to borrow against your deposit in the form of a loan.  The loan will report to your credit report as you make monthly on-time installment payments.

Another alternative that is available is a website called SelfLender.com.  I highly recommend this option because it is relatively easy to build credit using your own money and it forces you to save and it saves you the risk of obtaining money upfront and spending it all before being able to pay it back. Self Lender will allow you to do the same thing you could do with a CD at your bank.  You begin with your income and they determine a loan amount that you could safely afford to pay into for 12 months.  The safety in this option is that you do not really get a loan but yet, you commit to a set dollar amount per month that you feed into a savings account.  As you pay into the saving account, every payment is reported to your credit reports as a loan, after 12 months, you gain access to the money you’ve been storing away and the loan is then reflected as paid in full plus you earn interest on the savings account the same as a CD! You can apply for Self Lender and pay a small $12 processing fee and get started on rebuilding your credit. This is like using your savings account to build credit.

One Day at a Time

Rebuild

There is so much information online through many reputable resources to help you with managing your credit properly.  Start with places like creditkarma.com and myfico.com. While Credit Karma will provide you with access to your credit reports and Vantage Scores, MyFico will offer you access to your actual FICO score and credit report for a fee, however, MyFico.com has very robust community forums that discuss so many credit topics and this forum is free to access!

Rebuilding your credit is difficult but it is not impossible.  It will take commitment, honesty, and education to make it happen.  Be committed to meeting your goal.  Be honest about your situation and make the cuts you need to make.  Lastly, learn about credit and how to properly use it to your advantage.  Credit is not extra money but it is another way to spend the money you already have.  Just like money, credit is a tool, much like a hammer. You must learn how to use it, when to use it, and why you use it.  If used properly, it can provide you with a lot of financial success and leverage. You can take a hammer and build a study dog house and you can take that same hammer and smash it to pieces. The choice is yours.

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