When used responsibly, credit cards and loans can be amazing tools. Using a credit card instead of cash allows you to maintain a detailed record of your spending, and racking up rewards points can save you a lot on large expenses.
Loans make it possible to spread out payments on big-ticket items like a house and can help you fund a small business or your education. Point being, you’ll probably have a credit card and/or a loan at some point in your life. But what happens if you mess up your debt payments and your credit score drops? Is there anything you can do to fix the situation?
The short answer is yes — but it’ll take some time. I’ll walk you through some actions you can take.
What is a Credit Score and Why Is it Important?
Lenders look at your credit score (aka FICO score), which is influenced by your past financial behaviors, as a way to tell how risky it would be to lend money to you.
Your FICO score is based on different factors, including the length of your credit history, how responsible you are at paying bills on time, how many debts you have, what mix of credit you have, and any new lines of credit you add.
Maintaining a credit score of 700 or higher opens up your options. You’ll qualify for lower interest rates on loans (which can save you thousands of dollars in interest while you repay the loan), as well as credit cards with better rewards.
But a low credit score can affect your life in other ways. It might be harder for your application to a rental home to be accepted, for example. Utility, cable, and cell phone companies are less likely to want you as a customer.
So, as you can see, it’s essential you raise your credit score!
Fix #1: You Goofed Once
You’re normally a stickler for making on-time payments, but you forgot to once. Are you forever doomed to pay a ton of interest?
Probably not! Simply call your lender or credit card company and explain the situation. Many forgive your first late payment anyway, and a quick explanation followed by a prompt payment should prevent this from damaging your credit.
Prevent this in the future by setting up payment reminders, or even set up auto-payment through your bank.
Credit bureaus usually don’t report the payment as late until 30 days, so make sure you fix this ASAP and it won’t show up on your credit report as a late payment.
Fix #2: You Got Into Credit Card Debt
You routinely charge more than you can afford, and when the bill comes, you make the minimum payment to keep the credit card company off your back. It’s all good, right?
Wrong! You’re on the hook for interest payments for the outstanding balance — and many credit cards charge around 20% interest!
To get out of the credit card debt cycle, you need to take action. First, stop using your credit cards. Put the cards in a bowl of water in the freezer. This makes them hard to use. You’re going to have to cut back on expenses for a time until you pay the debt down. Work debt repayments into your budget and pay more than the minimum amount each month.
One option would be to transfer your balance to a different card with a zero-interest introductory offer. But keep in mind that this offer is temporary (usually about 6-18 months) and the interest rate will climb back up. Pay your debt off, interest-free, before the offer ends! Many companies charge a balance transfer fee of 3%, so it might not even be worth it to move the money.
Fix #3: You Maxed Out Your Credit Card
Let’s say you have two credit cards. One has a $6,000 credit limit, and the other has a $4,000 limit. That means you have $10,000 worth of credit.
If you’re regularly charging $10,000 a month (or even close to it), you’re negatively impacting your credit score. This is because of your credit utilization ratio — the amount of credit you actually use, versus the amount of credit you have available to use.
Ideally, you want to keep your credit usage to no more than 30% of your available credit. If you’re maxing out your cards, you need to take a hard look at your budget. What are you spending money on now that can be cut?
Another thing to consider is this: are you still holding onto your one credit card from college with a low limit? You might be maxing out your card now because your spending needs have changed since your college days. Call your credit card company to see if they can raise your limit, or apply for a different card that has a higher credit limit and better rewards.
Fix #4: You Have an Old Debt in Collections
You’re eligible for one free credit report from each of those credit bureaus per year — that’s three reports per year! You can check one per quarter to keep an eye on your credit year-round.
If you have a old debt in collections on your credit report, find out how long it’s been there as well as the statute of limitations on old debt in your state. Each state has different rules and it may restart the clock on when the company can collect the old debt if you work out a payment plan with them.
However, every month you have something in collections on your credit report, it is negatively affecting your credit. Old debts will fall off of your credit report in time but I rarely recommend waiting it out.
Fix #5: You Find An Error On Your Credit Report
It’s important to periodically check your credit reports because your credit score is based off of the information on them. Sometimes credit reports have errors on them that can affect your credit score.
If you catch a mistake, you need to report it to each of the three major credit bureaus (Experian, TransUnion, and Equifax) generally by writing a letter and sending it via certified mail. Here is a sample dispute letter that can help be your guide.
Here’s an article from the Federal Trade Commission on disputing errors on your credit report that might be helpful as you go through this process.
You Can Fix This
If you have a low credit score, it’s not the end of the world, but it is important that you take action in order to improve it. It’ll take a bit of work and some habit changes, but you can raise your score over time.
A high credit score is becoming more and more important when it comes to getting a job, renting an apartment, and obtaining car insurance. Hopefully, you’re now more aware of what you need to do to take the next steps in improving your credit.