If you've suffered a major blow to your credit, like after going through a foreclosure or filing for bankruptcy, but are now financially back on your feet, it's probably time to think about rebuilding your credit.
Some steps to improve your credit are relatively easy, like making sure that your credit reports don't contain inaccurate information. Others can be a bit more difficult and will take some time, like making sure you don't fall behind in your bills again. Also, counterintuitively, one way to start improving and repairing your bad credit is actually by getting new credit.
You might think that to reestablish good credit, you need to jump back into the credit market as soon as possible by applying for new credit. But that's generally not correct. Some of the ways to improve your credit that don't involve getting new credit include:
Once you are back on your feet financially, and have taken the steps discussed above to improve your credit, it might be time to consider getting new credit.
Here are some of the various ways you can get new credit if you're trying to rebuild bad credit.
One way to begin rebuilding bad credit is to get a credit card. Though, first you should think about whether you really need one. If you don’t currently have a credit card, it might make sense to apply for one. But if you already have one or more credit cards, applying for an additional card won’t help your credit score and it might lower it some. Here's why:
Around 10% of your FICO credit score is based on new credit or new credit inquiries. Because taking out new credit or making a lot of credit inquiries might suggest that you’re desperately seeking more credit, this negatively affects your credit score. Also, another 15% of your FICO score is based on the length of your credit history. New credit accounts bring down the average length of your credit history.
If you decide it's worthwhile to get a new credit card, but can't qualify for a regular unsecured card, think about getting a secured card. With a secured credit card, you deposit a sum of money with a credit union or bank and are given a credit card with a credit limit for a percentage of the amount you deposit—as low as 50% and as high as 120% (typically as a promotional incentive).
While these cards tend to be expensive, many can later be converted to a regular card. One major downside of secured credit cards, though, is that some creditors don’t accept or give much weight to credit history established with a secured credit card. Before you apply for a particular card, ask the card issuer if it reports to the three nationwide credit reporting agencies (Equifax, Experian, and TransUnion). If the issuer doesn’t, you’ve lost an important benefit of having a secured card.
If you can’t get a credit card or loan on your own, consider asking a friend or relative to cosign or serve as guarantor on an account. A cosigner promises to repay a loan or credit card charges if the primary debtor defaults. A guarantor promises to pay the credit grantor if the primary debtor does not. Cosigners are usually used in consumer credit transactions. A guarantor is more likely to be used for business credit. Although creditors usually report both your name and the cosigner’s name to credit reporting agencies, confirm in writing with the creditor that the account will be reported in your name.
A “credit-builder loan” is basically what it sounds like: a loan designed solely for the purpose of helping you build good credit. Some credit unions and community banks, as well as a few online lenders, offer these types of loans.
Here’s how this kind of loan often works: You fill out an application and, after you’re approved for the loan, the borrowed money is deposited in a savings account or a CD and held as collateral. This means you don’t get access to the money initially. The amount of the loan is typically small, around $500 to $3,000, and lasts 12, 18, or 24 months. You make monthly payments on the loan and the lender reports those payments to the credit reporting bureaus. Once you pay off the loan, you may access to the money in the savings account.
This is a usually a win-win for the borrower and lender: you get a better credit score and the lender doesn’t have to shoulder much risk because it can simply reclaim the funds in the account if you default on the loan. But if you don’t make the payment by the due date each month, the lender will report the late or missed payment to the credit reporting agencies and your credit will not improve.
You’ll want to make sure that the lender will report the account to the national credit reporting agencies. Otherwise, the account won’t help you build your credit.
Sometimes, local businesses will work with you to buy items on credit. You might be able to set up a payment plan with the store to purchase an item, and then make all payments on time. Again, this will only help your credit if the business reports to the national credit reporting agencies.
When calculating a credit score, FICO and other scoring companies look for a healthy mix of different types of credit, both revolving and installment accounts. So, if you have credit cards and a mortgage, you might consider getting a different kind of loan, like an auto loan. Your score might go down at first, but if you make your payments on time, your score will probably start to go up. If you're looking to improve your score quickly, don't use this tactic—it's more of a long-term strategy.
And, of course, before applying for new credit, make sure you're financially ready.