Although the financial climate is improving and unemployment rates continue to decrease, many consumers are struggling. Last year alone, the U.S. Courts reported nearly 1 million cases of Chapter 7 and Chapter 13 bankruptcy filings.
How does a financial hardship like bankruptcy affect your long-term credit health? For one, the damage can remain on your credit report for seven to 10 years.
If your credit is severely damaged because you filed for bankruptcy — or for any other reason — you can still take steps to repair it. In order to do so, though, you need to make sure you don’t hurt your credit even further. Avoid sabotaging your credit repair efforts by steering clear of these common pitfalls.
1. Failing to Budget
Where does credit repair begin? With a budget, of course. You wouldn’t travel without a map, and you shouldn’t spend money without a game plan. Creating a budget allows you to identify:
- Spending and saving habits
- Areas that need improvement
- Progress over time
Depending on your motivations, the sum of these factors can help or hurt your credit. Gather the facts, and begin tracking your monthly expenses.
2. Ignoring Your Credit Reports
A 2013 Federal Trade Commission study revealed that one in five consumers had an error on at least one of their credit reports — and these errors can seriously affect your credit score.
“People who know their FICO scores are in the driver’s seat when it comes to understanding credit and obtaining the best terms for themselves,” said Jim Wehmann, executive vice-president of Scores for FICO, in a 2014 press release. Take Wehmann’s advice and assume an active role. Review free copies of your credit reports, and check your credit score regularly.
3. Maxing Out Your Credit Cards
Good credit means maximizing its use, right? Wrong. Pushing your credit cards to the limit can affect your credit utilization ratio, which is the amount you owe in relation to your credit limit. A high ratio implies risk, a factor that is sure to hurt your credit score.
For a clean approach, aim for a ratio of 25 percent or less. For example, if your credit card has a $10,000 limit, maintain a balance of $2,500 or less.
4. Closing Old Accounts
In the world of credit scoring, age is a virtue. While you might think closing an old and unused account is wise, its impact could negatively affect your score by increasing your credit utilization ratio.
For example, suppose you have two credit cards, each with a $10,000 limit. Card A carries a zero balance, and Card B has a balance of $3,200. You decide to close Card A since you never use it, effectively losing $10,000 in available credit and raising your overall utilization ratio from 16 percent to 32 percent. Breathe life into your score by keeping your accounts current and active.
5. Applying for Too Many Accounts
Although new credit plays a vital role in an active score, applying for too many accounts can send the wrong message. Each credit application places a hard inquiry in your file. Too many hard inquiries can ding your score and imply risky behavior. Protect your score and reputation by practicing discretion.
6. Co-signing Loans
Suppose your friend needs help securing a loan. They know you have been working on credit repair, so they ask you to co-sign the application. Vouching for a friend’s loan means:
- Placing the account on your credit reports
- In some cases, increasing your credit utilization ratio
- Assuming responsibility for the debt if your friend fails to pay
- Suffering credit damage if your friend behaves irresponsibly
Achieving credit health is an individual process. Limit variability by delivering a polite and firm “no.”
Here’s the bottom line: Credit repair can be challenging, and your recovery time depends on the severity of past mistakes. But don’t allow current struggles to affect your long-term future. Take a proactive stance to ensure financial strength.