Ways to Rebuild Your Credit

Learn about ways to start improving and rebuilding your bad credit.

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.

How to Improve Your 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:

  • Disputing inaccurate or outdated information in your credit report. The first step to getting a better credit score is cleaning up your credit report. Disputing and resolving errors can have a positive effect on your score.
  • Adding positive information to your credit report. Consider adding information that demonstrates your financial stability, such as your job and address.
  • Pay your bills on time. Regularly making late payments can significantly hurt your credit. So, pay your debt obligations on time each month.
  • Pay your balance in full every month, if possible. Paying your balance in full keeps your credit utilization ratio (the percentage of your total credit lines that you're currently using) low—the smaller, the better.
  • If you can't pay the balance in full, pay down your credit card debt strategically, and then keep your balances low. Because credit scoring companies look at your debt ratio when calculating your score, you can raise your score by paying down cards that have a higher utilization ratio. For example, say you have one card, which has a $6,000 credit limit and a $3,000 balance. Another card has a $11,000 limit and you have a $1,100 balance on it. The first card has a 50% ratio, which is high, and the second has a 10% ratio, which is good. You can raise your score by paying down the card with the higher ratio. Generally, you shouldn't use more than a third of the available credit on your credit cards. If you exceed that threshold, it hurts your credit.
  • Using existing credit cards wisely. If you still have a credit card or a department store or gas card, use it and, again, pay your bills on time.
  • Getting credit in your own name. If you're married, divorced, or separated and most of the credit accounts are in your spouse’s name, consider getting some in your name.
  • Increasing the credit limit on your existing credit cards. If the amount you owe is close to your credit limit, that’s likely to have a negative effect on your credit. Though, be careful with this tactic: if you've missed payments or if your score is trending downward, the card issuer might think you’re about to have a financial crisis and you're desperate to get the extra credit. As a result, the issuer might actually decrease your credit limits. So, make sure your financial situation appears stable before asking for an increase. Also, don't use this tactic if you have problems with overspending.
  • Not closing old accounts. It's usually a bad idea to close older credit card accounts. You might think of this step as cleaning up your credit. But in the case of credit cards, it usually helps to hold on to older accounts for a long time, which gives you a more established credit history. If your older card charges an annual fee, as the issuer to switch to one that doesn't have a fee, while keeping your history.

Rebuilding Your Credit By Getting New Credit

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.

Get a New Credit Card

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.

Get a Secured Credit Card

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.

Get a Cosigner or Guarantor

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.

Get a Credit-Builder Loan

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.

Buy an Item on Credit From a Local Merchant

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.

Get a Mix of Credit

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.

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