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Your credit can be damaged in many ways, both small and large. If you max out your credit cards around the holidays, you’ll see your credit score take a dip until you pay those balances down. If you miss a credit card or other loan payment, that will be reported to the credit bureaus and your score will immediately suffer.
On the more serious end of the spectrum, if a bill is sent to a collections agency or you declare bankruptcy, your credit score will suffer serious damage that can take years, or even a decade, to recover from.
The good news is that rebuilding credit is possible. The bad news is that just like establishing your credit for the first time, there are two indispensable requirements: the passage of time, and the continued discipline to handle credit responsibly.
How long does it take to rebuild credit? It depends on the reason your credit score suffered in the first place. That’s why the first step to rebuilding your credit is identifying which elements of your credit report are hurting your score.
Each month, your credit cards and other loan accounts report the amount of your outstanding loans and your maximum loan amount or credit card limit. If you are using 50% of the credit available on any one account, or 50% of your total available credit across all your accounts, your score will suffer compared to credit users who keep their account balances below those thresholds. The effect happens on a sliding scale. Sixty percent utilization hurts you more than 50%, but 40% hurts less.
Credit utilization is worth a huge portion of your credit score – 30% – and is second in importance only to payment history. It is also one of the easiest elements of your credit report to improve. If you know you’ll spend a lot of money in a given month, one way you can protect your credit score by spreading your purchases around to multiple credit cards, keeping your balance on each individual card below 50%. However if you tend to carry a balance you will want to check the annual percentage rate (APR) on the cards you plan to carry a balance on as those finance charges can add up quickly.
If you carry balances from month to month, you can also rebuild your credit score by paying down the cards with the highest utilization rates first, but very important you still need to make on-time payments of at least the minimum due on on all your credit cards if you choose to do this. Just remember: the lower your credit utilization rate on individual cards and across all your credit accounts, the higher your score will be.
Depending on when your credit accounts report your balances to the credit bureaus, it can take up to a couple months before your lower credit utilization starts to show positive effects on your credit score.
Take a look at some startling numbers around credit utilization, from Credit Sesame’s data.
Late and Missed Payments
Lenders want to see a long, unbroken history of on-time payments across every one of your credit accounts. The more late and missed payments the credit bureaus show on your credit report, the lower your credit score will be.
A single late payment will hurt your credit score, but it’s not the end of the world. Things start to get worse when the payment is 60 days late. Prepare for another hit when it reaches the 90-day mark, and even more damage if it gets to 120 days late and is turned over to a collection agency.
If you give up on making one or more payments completely, the damage will compound and seriously damage your credit score, making it more difficult, and more time-consuming, to get back on track. That’s because a missed payment will have a negative effect on your credit score for 7 years, so although the damage diminishes over time, your credit score will only fully recover 7 years after your last missed payment. It’s imperative to resume on-time payments as quickly as possible.
Some lenders offer options to delay or restructure your repayment terms. For example, the federal government offers income-based repayment to many student loan borrowers, which can reduce or even pause repayments on federal student loans (private loans are not eligible for income-based repayment). If you’re having trouble making your student loan payments on time, contact your student loan servicer and ask about your options to restructure your payments.
Understandably, having a bankruptcy on your credit report may be the single most devastating thing that can happen to your credit score. Regardless of whether you filed for bankruptcy after an expensive medical emergency or the loss of a job, many banks will steer clear of you and refuse to make unsecured or long-term loans as long as the bankruptcy is on your credit report. If you are able to borrow money for a car or other large purchase, you’ll face higher interest rates and shorter repayment terms than borrowers who haven’t discharged their debts in bankruptcy.
The most common Chapter 7 personal bankruptcies remain on your credit report for 10 years. Chapter 13 workouts, where lenders receive some percentage of their claims over a 3-5 year period, remain on your credit report for 7 years.
After filing for bankruptcy, you may despair that your credit report will be ruined forever. Not true. Rebuilding credit after bankruptcy is difficult, but not impossible. Under most circumstances, student loans aren’t discharged in bankruptcy proceedings, which gives you an immediate opportunity to establish a post-bankruptcy history of on-time payments by making your student loan payments on time and in full each month.
If you choose to reaffirm your secured debts in bankruptcy, you can continue making your mortgage payments, giving you an additional source of on-time payment history data. Some landlords also report on-time rent payments to the credit bureaus; check with your own landlord to see if they do this, or if they’re willing to start, since your rental history reports can be an asset to your credit.
Best Credit Cards to Rebuild Credit
There are three ways you can use credit cards to rebuild credit. First, since your credit utilization rate is an important factor in the calculation of your credit score, focus on paying down and ultimately paying off your debt by not adding any new debt to your credit cards.
Second, each credit card account typically reports your outstanding balance and payment history to the three major credit bureaus, and each month that you pay at least the minimum amount due on time counts as a positive mark in your credit record. The more on-time payments you have, the less your score will be hurt by a single late or missed payment.
Finally, credit cards are also factored into the average age of all your credit accounts. So even a credit card you don’t use often, over the long term, gradually increase your average age of accounts and exert upward pressure on your credit score.
Once your score improves, you can look into applying for other types of cards that offer rewards, such as a miles credit card for travel so you can earn credit towards flights and travel. There are other rewards card where you can redeem your rewards for a variety of options such as cash back, statement credits, merchandise, charitable donations, gift cards – the redemption options available depend on which card you select.
Unsecured Credit Cards to Rebuild Credit
If you have bad credit, you’re unlikely to be approved for unsecured credit cards with high limits or lucrative rewards. You might initially be approved for a credit limit of just a few hundred dollars. However, over time, responsible use of that credit card by you will have a steady positive effect on your credit score and enable you to qualify for better credit products.
When applying for unsecured credit cards to rebuild your credit, a couple of things to keep in mind are, is there an annual fee and if so how much is it, and the interest rate for your transactions, the Annual Percentage Rate (APR) for purchases, balance transfers and for cash advances. Knowing what APR you will be charged is especially important if you carry balances from month to month. The annual fee is important because your goal is to establish a long average age of accounts: you want to carry these cards forever, so the lower the annual fee, the less you’ll pay over the long term. The interest rate, or APR, charged on purchases and balance transfers can make it either very expensive or relatively cheap to carry balances from month to month.
Secured Credit Cards to Rebuild Credit
Unfortunately, if you have bad credit, especially after a bankruptcy, you may not be approved for an unsecured credit card. In that case, you can consider applying for a secured credit card. These credit cards work just like a regular credit card, except instead of the bank extending you credit based on your history of managing your credit responsibly, they give you a credit line typically equal to the amount of cash collateral you’re able to deposit with them to secure the loan.
Check with the card issuer to make sure your payments are reported to the three major credit bureaus so your transactions and credit behavior will be documented. Take the opportunity to build a history of on-time payments, and after you’ve demonstrated the responsible use of your secured credit card, you can either ask to be moved to an unsecured credit card or apply for a new unsecured credit card and close the secured card. In either case, you’ll receive your collateral back, assuming you’ve paid off all your charges and met all your obligations on the card.
Discover it® Secured
I think the best secured credit card that’s available nationally is the Discover it® Secured card. The Discover it® Secured card is a real credit card that allows you to build credit history with the three major credit bureaus. This is in contrast to debit and prepaid card that generally can’t help you build a credit history. You can establish your credit line by providing a refundable security deposit from $200-$2500 after being approved. Bank information must be provided when submitting your deposit.
Discover will start automatic reviews at 8 months to see if Discover can transition to an unsecured line of credit and return your deposit. Keep in mind that these reviews take into consideration all of your credit cards and loans, including Discover and others, and are based on your credit management.
The Discover it® Secured card has a couple of advantages over other secured credit cards on the market. First, like all Discover cards, it has no foreign transaction fees, so you won’t pay 2-5% in additional fees when you use your credit card for purchases outside of the United States. It also has no annual fee.
Second, it offers a cash back rewards program on purchases made with the card – 2% cash back at gas stations and restaurants on up to $1,000 in combined purchases every quarter, automatically. Plus, earn unlimited 1% cash back on all other purchases. Icing on the cake: Discover will match of all the cash back you’ve earned at the end of your first year, automatically, for new cardmembers only.
Capital One® Secured Mastercard®
I think another good secured credit card option is the Capital One® Secured Mastercard®, which has no annual fee. With the Capital One® Secured Mastercard® you will get an initial $200 credit line after making a security deposit of $49, $99 or $200, determined based on your creditworthiness.
The Capital One® Secured Mastercard® also has no foreign transaction fees, but unlike the Discover it® Secured card it doesn’t offer a cash back rewards program. For that reason, I believe the Discover it® Secured card may be a slightly better value, despite the somewhat more limited acceptance of Discover cards compared to Mastercard®.
Other Secured Credit Cards
Besides Discover and Capital One, most large banks offer secured credit cards, some of which may have annual fees. In addition, if you tend to travel outside of the United States check the credit card terms as some card issuers may charge foreign transaction fees on your purchases, so if it can be at all avoided, try not to use cards that charge a foreign transaction fee for purchases made outside the United States. Many local credit unions offer their members a secured credit card to help them build or rebuild their credit.
Finally, remember it’s up to you to handle your credit obligations responsibly in order to improve your credit.
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