How to Fix and Deal With Bad Credit
How to deal with bad credit isn’t as easy as it used to be. Not so long ago, when you tried to avoid bill collectors, you just let the phone ring or you ripped it off the wall if the calls became too frequent.
Today, those avoidance tactics won’t do you much good because your bad credit can and will follow you everywhere. In many ways, you’d be better off tangling with a rabid dog than having bad credit constantly nipping at your heels. There's no escaping it:
- If you’re looking for a job, about half of all employers will now ask to run your credit. Gulp!
- If you’re searching for a place to rent, chances are the management company or landlord will require a credit check. Oops!
- If you want to buy a home or a car, you’ll pay a substantially higher interest rate -- that is, if you even qualify for a loan. Gasp!
- And when you go to insure your home or car, you’ll pay more for that, too. Yuck!
You could just decide to drop off the grid and try to live an all-cash, credit-free existence, but good luck trying. To live like a Tibetan monk high in the Himalayas, unlinked to the world, you’ll probably need to book a hotel, reserve a flight and rent a car to get there, and all those simple acts you might have long taken for granted, REQUIRE A CREDIT CARD!
Ah, but maybe you’ve convinced yourself that a debit card can serve as a great stand-in for most of your financial transactions. It’s true, you can use it to buy gas, groceries and get cash back, but when use your debit card for everything, you’re missing the party. Credit card holders, more than ever, get cash back or airline mile rewards every time they swipe their card. That's the punch bowl you want to be drinking from!
There’s no reason you have to continue living in credit purgatory just because you lost a job, suffered an illness, lost a business or racked up too much debt living beyond your means. That was the past. You have to start thinking about the future, and that future will likely include a better credit profile than the one you currently enjoy.
Fortunately, there’s a solution or a workaround for nearly every poor credit situation, but before looking at those, you first need to take a tourniquet to your current financial situation so that you don’t drain your finances or damage your credit further.
The road to credit score recovery
First, you have to realize that it’s a long road to repair your credit -- to go from subprime (under a 620 FICO) to the sublime (better than 740 FICO). There are no quick-fixes, magic bullets or instant remedies for what ails you. The only solution involves a long, sobering, uphill slog. But you can’t let the thought of the journey ahead overwhelm you. You have to start now, because, as we mentioned, living with poor credit can impact everything about your life -- from where you sleep, to where you work, to what you eat.
As with any recovery program, you first need to size up your current condition. There’s good news on that front because anyone can get a credit report for free once a year by requesting a credit report on AnnualCreditReport.com, a service provided by the three major U.S. credit reporting agencies, Equifax, Experian and TransUnion. You can choose to receive reports from all three bureaus at once or stagger your requests over the 12 months as a way to periodically check your credit data. Your credit score, however, is not included in any of the three reports.
Nevertheless, you can pore over the reports to correct reporting mistakes that are weighing down your score. For example, if you’ve gone through a Chapter 7 bankruptcy, check all your accounts to see that all your former creditors were listed as part of your bankruptcy and that all accounts now show a zero balance. You can also request that the agencies insert a note into your report, explaining an especially rough patch that hurt your score, such as a job loss or illness.
Looking at your report is also an eye-opener in the sense that debts or non-payments on your accounts don’t fall off your credit history for seven years. Upon seeing some of those debts, you might ask yourself, of all those items you purchased, how many are you still using today. In bold black and white, your credit reports might serve as a wake-up call for your overspending problem.
Stop debt and overspending
Before you can start improving your credit, you need to stop feeding and growing your debt. As tempting as it might be to cut up your cards, however, just lock them up. That’s because the length of your credit history -- the longer the better -- accounts for roughly 15 percent of your credit score. Were you to terminate your oldest credit cards, you could actually lower your score. You’ll also need a credit card when that’s the only form of payment a vendor will accept.
Your next order of business is to raw up a budget that shows your cash inflows and outflows down to the dollar. This is a painful, but necessary process. It hurts to see how easily rent or a mortgage, utilities, insurances, car payments, fuel, food, credit card bills, daycare expenses, and other outlays can overwhelm even some six-figure incomes.
So many categories of spending, however, also present you an equal number of opportunities to reduce expenses. Aim for a 10 percent spending reduction right off the top, but, by all means, aim higher if you can! MyBankTracker has taken special joy over the years in helping readers identify ways to save, such as curbing transportation costs by carpooling or taking public transportation, cutting restaurant expenses by brown-bagging it, and reducing communication costs by severing cable or satellite or the landline in your home. Wield a sharp axe! Every reduction you make is like giving yourself an instant pay raise.
Your next move is to pick up that constantly ringing phone and to start negotiating with your creditors. The fact you locked up your credit cards and vowed to stop using them didn’t make your debts go away. Your negotiations can follow several different paths, as briefly explained below:
1. Modified payment plan
Just the fact you’re no longer avoiding your creditors’ calls shows good faith, so use that bit of goodwill to ask to get a fee or penalty waived on your account. Also ask for an interest rate reduction. Both of your requests might go nowhere, but never be afraid to ask. Next, ask how you can stretch out your payments to a more manageable level. Most creditors will show some flexibility, as they know any payment is better than no payment.
3. Debt settlement plan
If you can’t work out a modified payment plan, you might consider a debt settlement plan. This course of action will likely take your credit score lower than a modified payment plan, but at least it will get your debt behind you. When creditors sell their debt to a collection agency, they might sell it for 10 cents on the dollar, sometimes more, sometimes less, depending on the age and history of the debt. So, if you were to start your negotiations by offering a bill collector half of what you owed, say, $500 on a $1,000 debt, you might get some interest or a counteroffer. You could offer even less to start, that’s why they’re called negotiations.
If you can’t make one lump-sum payment, because it’s simply not in your budget, offer to make smaller payments: perhaps, $100 a month for five months.
4. Credit Counseling Agency
Admittedly, trying to fix your financial situation by yourself can be tough. You might not find it easy to pick up the phone and engage in hard-knuckle negotiations, where you might be cajoled, insulted and threatened by commission-driven collectors who only get paid when you pay up. By speaking with a credit counseling agency first, you might develop an actionable plan for working down your debt. It will at least put someone in your corner to bounce some debt-reduction ideas and strategies off of. Many of these agencies offer their services for free, as they’re often funded by banks and credit card companies. Remember, you're trying to reduce expenses, not add to them.
5. Debt management Plan
The concept is simple enough. Each month, you give money -- usually via electronic deposit -- to a company specializing in debt management that in turn pays your creditors. As debt “experts,” working in your behalf, they claim to be able to lower your interest rates and monthly payments and get some fees waived. For this service, they charge a fee. In one sense, this is a debt consolidation plan, but don’t confuse it with a typical debt consolidation plan whereby you, on your own, go to a bank and get a loan -- perhaps a personal loan or a home refinance loan -- large enough and at a lower interest rate to pay off all your other loans. Rather than paying a consolidator, you’re the consolidator. This second alternative is a better way to go, but if you can’t obtain a consolidation loan because of poor credit, hiring a reputable debt management company to help you pay down your debt could be a viable option.
Immediate workarounds to keep you afloat
If bad credit has put you in a straitjacket, you won’t have a lot of wiggle room or margin for error, but you shouldn’t be discouraged. You can make significant headway across a number of fronts to keep you functioning while your credit picture slowly improves. Here are some examples:
At the outset, we mentioned that about half of all employers will run your credit. You’ll know when a prospective employer is about to run your credit because you’ll be asked to complete a Fair Credit Reporting Act (FCRA) disclosure and release form.
If the subject of your finances comes up in an interview, be ready to speak proactively. Be prepared to address what contributed to your poor credit score, how it had no impact on your work performance, what you learned from the experience and the measures you took to prevent it from recurring, as well as the steps you’ve taken to raise it going forward.
If you’re working with a recruiter, be upfront about your financial situation. Your recruiter might be able to suggest strategies for addressing the issue when it comes up in an interview or put your mind at ease as far as your credit not being a deal breaker for a particular open position.
Lastly, you might have to work as a contractor, consultant or freelancer while you work to improve your credit. Just continue to be conscientious and forthright in all your employment discussions. Few people escaped the Great Recession without a credit ding or two, so you might find employers more receptive to your financial situation if you can show you’re now moving in a positive direction.
Put yourself in a landlord’s shoes. Who would you rent to if two applicants were exactly the same in every category, except one had worse credit than the other? You know the answer.
But what if you were the only applicant? Then the landlord has to choose between you and waiting for a more financially capable prospect, at least on paper, to come along. You can improve your eligibility by offering to pay a higher security deposit. You might also offer to bring in a co-signer. If you pursue the higher security deposit option, ask that it be made refundable at the end of your lease or even earlier if you can show your credit has substantially improved.
You might also consider finding a roommate while your credit score is in the dumps. If your roommate has better credit than you, let him or her sign the lease.
Car loan search
It seems that no matter how bad your credit it is, there’s always a car dealer ready to sell you car. You usually hear their pitches on late night TV. You will likely pay a stratospheric rate for the privilege, however.
The better road to take would be to delay any purchase while you continue to build up your credit (See what credit score is needed to buy a car).That way, you’ll get a better interest rate. For as long as you can, try to go carless for having been careless in the past with your credit.
If you must purchase, buy a used vehicle, not a new one. The size of the average used car loan is about $18,000; for a new car, it’s about $28,000.
So that you don’t get completely clobbered on your interest rate, try to put down as much as you possibly can to make your monthly payments more manageable. Another workaround would be to try to get a cosigner on your loan -- someone with better credit than yourself -- to receive a lower interest rate, but, of course, if you fail to make a payment, you could jeopardize that personal relationship or friendship.
If you’re stuck with a high interest rate, resolve to keep improving your credit, so at some point, you can refinance your loan to a lower interest rate. It might take some doing, but banks are a competitive bunch, so put this knowledge to your advantage. It could save you hundreds of dollars over the life of your loan.
Home loan search
After the release of new guidelines by mortgage giants Fannie Mae and Freddie Mac this month, banks are beginning to ease their lending standards to accommodate more home buyers with less than stellar credit. The Urban Institute, a Washington think tank, estimated that as many as 1.2 million additional home loans would be made under the new guidelines.
Home loan borrowers who can’t obtain a loan with a large bank like Wells Fargo, the nation’s largest mortgage lender, should also consider shopping for a loan with a mortgage banker, which typically offers a greater variety of loan products and programs.
Borrowers with credit issues should also consider asking home sellers if they’d be willing to carry a second mortgage. Some sellers of homes that have been on the market longer than average might consider this seller-financed option to complete the transaction.
Get a secured credit card
If you’re in the process of re-establishing credit, getting a secured credit card is a great way to start. To obtain a secured credit card, you will be asked to put up a collateral cash deposit equal to your approved credit limit. So, for example, if put $1,000 into your account, you could charge up to $1,000.
That way, the bank is protected against the risk of default. By making your monthly bills on time with your secured card, your bank will report your payment information to the major consumer credit bureaus, enabling you to build your credit score.
Banks like the secured credit card business because they make money while holding your deposit. They also make money from any fees associated with opening and maintaining your account. (Some banks or credit unions waive their annual fees.) Furthermore, secured credit card issuers collect interest when you don’t pay off your balance in full each month.
The point, of course, of using a secured or unsecured credit card (one not backed by collateral), is so you have a card to book a hotel room, make an airline reservation, or rent a car.
There are ways, for instance, to rent a car without a credit card. Enterprise will rent you a car if you can show them two utility bills from your current place of residence, but it’s lot more convenient to produce a card than it is rummaging through a bunch of old utility bills.
You’re not alone
According to a study by the Corporation for Enterprise Development, more than half of consumers in 37 states, plus the District of Columbia, have credit scores too low to receive the best or prime interest rate.
As shown, there are ways to function with bad credit and there are ways to begin restoring and repairing your credit score so you’ll find it easier to get a job, rent a house, buy a home, or simply book a hotel room or get a cell phone contract.
It’s true there was a time, when you could miss a few payments or skip out on a few bill collectors, and the consequences, while serious, were not so severe that they hounded you in almost every aspect of your life.
Those days are over. How to deal with bad credit is an issue you need to address if you’re among the less desirable half the CED study cited, and you want to start living again.
There are solutions available to you. But making the solutions work, takes planning, patience and persistence. No plan will work without it!