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Sep 27 2010 12:00AM

Question


How long does it take to clean up “bad credit”? How can you increase your credit number if no one will give you any credit cards, loans, etc.?

Answer


“One’s credit rating is very important in the world of finance,” said FPA member William J. Taylor CFP®, vice president and senior trust officer at F & M Bank.

And the best place to start is with your current credit report. “The report has a lot of information that can be very helpful in determining the best course of action and the order of steps to improve the rating,” Taylor said. “A rating may include judgments, tax liens, foreclosures, bankruptcy and collections.”

“Each item on the credit report should be reviewed and satisfied by paying the item in question or receiving an understanding that the item is not longer due,” Taylor said. “Bankruptcy is the hardest item to erase from the report. Establishing positive credit relationships and time are the best solutions in overcoming bankruptcy and the other problems on a credit report.

“To establish credit when no one will give credit will first require building up your cash savings. Many banks and credit card companies offer a secured credit card to those with tarnished credit. The process is that you provide the bank or credit card company with funds, usually around $300. The bank or credit card company then provides you a credit card with a $300 limit. If you are able to use this secured credit card for an extended period by paying the full balance each month in a timely manner, you will be able to move to an unsecured card with a very low limit. If you are able to continue paying the balance on time every month, the credit limit will be raised. The company holds your funds just in case the card is not paid. Only a payment of the full balance should be considered to help improve the credit rating and to avoid an extremely high interest charge.

“Once you have a good history with the secured card and then an unsecured card for a couple of years, in which you have paid off the balance on time, you should be able to secure other types of credit such as a department store credit card or gasoline. The key it is that you must make every payment on time and in full. In additional time, perhaps another year in which all credit is paid on time and the balance is reduced, you will see the credit rating slowly rise. 

“If you are considering the purchase of a home, mortgage providers like to see at least three sources of credit that have been handled correctly. Federal Housing Administration (FHA) loans, which have the most forgiving terms and conditions to obtain a mortgage, require at least two years from the discharge date of a bankruptcy before an application will be considered. It can seem like a long process but is really the only way to build up the credit rating.”

In addition, Taylor said several principals that are very important in the financial planning process have been mentioned or implied. In general you need:

  • To save cash and have an emergency fund to pay for unexpected expenses. This emergency fund needs to be equal to three to six months of typical monthly expenses. 
  • To understand how much income you have each month in comparison to typical expenses. You need to have a budget and need to govern your expenses based on the budget. 
  • To save as much as possible for big ticket items such as cars and homes to decrease the amount of debt that you carry. The less debt, the more flexibility you have with your income and then less likely to run into situations where your credit rating is hurt. 
  • To build up your credit rating to be able to borrow money when absolutely necessary at the least cost.
  • To save for the future as well. Your budgets should include savings for retirement and other life events that require large amounts of cash.
  • To consistently review your financial situation to be sure everything is on track.

“Building up and maintaining a strong credit rating will be a slow process that may require many changes in your current lifestyle, but is well worth the effort,” said Taylor.

For his part, FPA member Thomas H. Zimmerman, CFP®, of Zimmerman Wealth Management, suggested that you visit the MyFico website for more information about credit reports and cleaning up bad credit.

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