5 Steps to Rebuilding Your Credit Score

by Brandon Cornett

In 2009, there will be a lot people rebuilding their credit due to foreclosures, bankruptcy and other factors. The housing crisis and other factors have caused problems for a lot of folks, and these problems usually culminate in the form of a bad credit score.

So if you're one of many Americans who will be rebuilding your credit over the coming year, you're not alone. The question is, how do you go about it? What steps are needed to rebuild a credit rating over time, and which steps should you focus on first? These are the questions we will tackle in this lesson.

Rebuild Your Credit Score With These Steps

Here are five of the most important things you can do as you venture forth in your quest for better credit.

1. Identify the Problem

Before you do anything of the other things on this list, you need to try and figure out why your credit score is bad to begin with. If this answer is obvious (like a bankruptcy filing or a long history of missing bill payments), then you can probably move on to the next step in the list. The key to rebuilding credit is to identify the bad financial behavior that caused the problem, and then to correct the behavior.

2. Correct Errors on Your Credit Report

If you've haven't ordered a copy of your credit reports in the last year, you should do it as soon as possible. It's not uncommon to find errors within your credit history. They may be data mix-ups, or they may be signs of fraud. Either way, they can drag your credit score down even lower.

I put this step high up on the list for a good reason. Fixing these errors can be a time-consuming process, so you should start right away. Start by ordering all three of your credit reports and reviewing them for mistakes. If you find a problem, you'll need to contact the company that produced that particular report (either TransUnion, Experian or Equifax). Remember, the rebuilding process begins by reviewing your current situation.

3. Reduce Credit Card Balances

Most financial experts agree that this is one of the fastest ways to improve a credit score -- if it's not the fastest. This is also one of the best things you can for debt reduction in general. Credit cards usually have a much higher interest rate than other forms of debt (such as student loans and mortgages). So when you pay these balances down, it helps improve your debt-to-income ratio at the same time you're rebuilding your credit score. You can see why this is such an important step in the process.

Right about now, you might be saying "easier said than done." It takes extra money to pay down these balances, instead of just paying the minimum balance each month. So where does the money come from? Well, you'll have to reduce your spending (see item #5) and work out a payment plan to whittle away at those credit card balances. It will take some discipline, but it's a crucial step needed to rebuild your credit rating.

If you need some professional help from a debt expert, check out the free debt counseling service available from Credit.com.

4. Pay All Bills on Time

Getting behind on bill payments (for auto loans, credit cards, etc.) is one of the key reasons why people get into bad-credit situations in the first place. In the first step above, I asked you to identify the source of the problem. If missing payments is part of the problem, you need to correct.

One of the best things you can do is to handle a bill as soon as you get it out of the mailbox. Putting it into a stack somewhere will increase the likelihood that it doesn't get paid. You can also set up online auto-pay to make your life easier -- just about everyone offers it these days.

5. Get Your Spending Under Control

When you spend more than you earn (as so many Americans do these days), you will inevitably build up a lot of debt. This is often in the form of credit card debt -- the worst kind to have! This is where discipline comes into the picture again.

Sit down and create a budget to see how much money you spend every month, and what you're spending it on. Now look for items that can be eliminated. Going out to dinner, going to the movies, buying luxury items you don't really need ... these are all things that can be scaled back or eliminated entirely. Rebuilding a bad credit score is all about awareness. You need to be aware of what you're making each month (after taxes), what you're spending each month, and how it's affecting your overall financial picture.