Unless you’re a monk or living in a cave in Borneo bad credit can have a seriously negative effect on your life. It can make it practically impossible to get new credit and can make it tough, if not impossible for you to achieve your financial goals in life. As an example of this, insurance companies may be unwilling to sell you the insurance you need. If you’re a renter looking for a new house or apartment you may find that potential landlords won’t rent to you. And a potential employer might not hire you because of your bad credit.
How your creditors see you
Your credit reports are records of how well or how badly you’ve managed your finances. The more negative information there is in your credit files the more difficult it will be for you to get credit with attractive interest rates. For that matter, if your credit history is in seriously bad shape there are creditors that won’t give you any credit at all. Others may give you new credit but only if you collateralize it with an asset. Of course, if you don’t own a valuable asset you could use as collateral, you won’t qualify for this type of credit either.
Your credit score is king
When creditors check your credit the main thing they look at is your FICO score. While there are other types of credit scoring systems FICO is the one used by most creditors. Your score is, of course, based on the information in your credit reports. So the more negative that information is, the lower your score will be. Creditors usually look at credit scores in terms of ranges as follows:
• 7821- 850: Excellent Credit
• 661- 780: Good Credit
• 601- 660: Fair Credit
• 501- 600: Poor Credit
• Below 500: Bad Credit
The first step in rebuilding your credit
If you’re serious about rebuilding your bad credit the first thing you need to do is get a copy of your credit reports from TransUnion, Experian and Equifax. The reason why you need all three is because they could contain different information. You are permitted by federal law to get your reports free once a year. You can get them separately by contacting each of the three credit reporting bureaus. Or you can get all three of them together on the site www.annualcreditreport.com.
Reviewing credit reports is tiresome and tedious. But you need to check each one carefully looking for errors or inaccuracies that are damaging your credit. If there are any of these on your reports, you need to disputes with the credit reporting bureaus. The best way to do this is by letter and by enclosing whatever documentation you have that proves your claim.
The second step in rebuilding bad credit is to begin saving. This is the foundation for most credit rebuilding. If you’re not now saving money on a regular basis you need to start and save as much as you can every month – even if it’s not a lot. You should have at least $1000 in a savings account. But don’t stop there. The ideal is to have at least six months of your living expenses in savings. If that doesn’t seem realistic, try for at least three months’ worth.
Use a credit card
It’s possible you could use either your Visa card or MasterCard to help rebuild your credit. There are two ways to do this. You could use the card to make small purchases each month and then pay off your balance in full and on time. Or you could use the card to buy something relatively expensive and then pay off the balance over time.
If you can’t use a credit card
If you have too much negative information in your credit reports, you may not be able to use an existing credit card or get a new one. In this case, you will need to get a secured MasterCard or Visa card. These cards look identical to regular credit cards except you need to deposit a certain amount of money in a savings account at the bank to secure your purchases. Or you might be required to purchase a certificate of deposit (CD) for a certain amount of money. The credit limit on that card will be a percentage of the money in your savings account or the value of the CD. In the event you don’t pay on your credit card according to the terms of your agreement, the bank is legally entitled to get paid by tapping your collateral, including interest and fees. It may also close your account or make you put up more collateral to keep it open.
You should also be sure that how you use your secured card is reported to the credit bureau used by the bank or credit union. The reason for this is that if you use it sensibly this will help you rebuild your credit.
If you’d like to know more about using secured credit cards effectively, here’s a short video with some helpful information.
Get a loan
The next step in your credit rebuilding process is to get a loan from a bank or credit union and then pay the money back on time. A good way to handle this is by setting up an appointment with a loan officer at your bank or credit union to discuss your needs. The best place to do this is at a bank where you have a savings and checking account. You will need to be upfront with the loan officer about your financial problems. She’ll see this anyway when she looks at your credit reports. Explain what you’re doing to improve your finances and let her know you have started the credit rebuilding process. And, as part of this process, you would like a small bank loan. If the bank or credit union turns you down be sure to find out why. You will then need to address the reasons why you got a thumbs down.
If you are able to get a loan, you will need to make all your payments on time and live up to whatever are the other terms of your agreement with the bank or credit union. Once you’ve repaid the loan, you need to get a copy of your credit history from whichever credit reporting bureau the lender reports to so that you can be sure that your loan-related information is accurate.
Apply for a second loan
A last step in your credit rebuilding process is to apply for another loan, hopefully with the lender that gave you the first one. If the first one was secured you may qualify this time for an unsecured loan. If not, get another secured loan. Eventually, over time, as the information in your credit reports improves, you’ll be able to get an unsecured loan.
Your credit going forward after bad credit
As your credit rebuilding process goes forward, assuming that you make all of your payments and on time, your credit history will gradually become more positive, your FICO score will go up and you will find it easier to get new credit at attractive interest rates.
Frequently asked questions about bad debt
If you have bad credit it’s because you have bad debt. Here are FAQs that will help you understand the relationship between bad debt and bad credit.
Q. What is bad debt?
According to the online encyclopedia, Wikipedia, “a bad debt is an amount owed to a creditor that is unlikely to be paid and which the creditor is not willing to take action to collect because of various reasons”., However in the case of personal bad debts most lenders will batch them up into a portfolio and sell to a debt collection agency or a private collection law firm. They generally sell debts for about 25% of their face value. If you had a $1000 debt it might be sold for $250 or much less.
Q. How long will a bad debt stay in my credit reports?
A. Bad debts will stay in your credit reports for seven years from the time you last made a payment on it or when you occurred the debt. This is what starts the seven-year clock. Your debt could be sold over and over and this won’t change the seven-year clock. The only good news is that bad debts typically decline in importance as the years go by. In other words, if you incurred a bad debt last year it will have much more of an impact on your credit than if it was six years ago.
Q. Who buys bad debt?
Debt collection agencies are who buys bad debt but so do private debt collection law firms. They generally purchase large portfolios delinquent or charged-off debts from credit card companies or even other collection agencies. They typically buy debts for pennies on the dollar. In other words, they might pay $25 for a $500 debt. A debt buyer can collect the debt itself, use the services of another collection agency, repackage and re-sell portions of the debts purchased or a combination of these options.
Q. How bad is debt settlement for your credit?
A. Debt settlement may not have a negative effect on your credit if you settle the debt yourself although this will depend on how your lender chooses to report it to the credit bureaus. But if you use a debt settlement company that requires you to stop paying your lenders and send the money to it instead, your credit will take a serious hit. The harsh truth is that anytime you pay less on a debt then what you owed, your credit will suffer.
Q. Are student loans considered to be bad debt?
A. Student loan debts are the very worst kind of bad debt. For one thing they can’t be discharged even by bankruptcy. But even more important our government is deadly serious about collecting on student loan debts. If you default on a student loan debt, the consequences will be serious. There will be collection fees added to your debt that will be anywhere from 18% to 40% of your outstanding balance. Your wages could be garnished and your income tax refunds taken to repay the debt.
Q. What our bad debt write-offs?
A. A bad debt write off is when the lender treats the debt as uncollectible, writes it off on its books and then uses it to help offset its income taxes. As you might imagine this can actually be a good thing for lenders. However, just because a lender wrote off a debt doesn’t mean you don’t owe it. A bad debt will stay in your credit reports until you either pay it off or it falls off your credit reports after the seven-year period mentioned above.