If you're strapped for cash and having trouble making ends meet, improving your credit score may be the last thing on your mind. Millions of Americans are suffering from dinged-up credit: the lingering result of the recession, the lack (until recently) of real increase in wages, the economy's sluggish growth. But a strong credit score is the backbone of an individual's financial health. With low or no credit, you can end up finding yourself paying far more for life's essentials than those who have strong credit. The importance of a good credit score goes beyond simply getting a low interest rate on a loan. A driver's credit score, for instance, is a major factor in pricing auto insurance.

Regardless of what has happened to you financially – whether you have gone through foreclosure or bankruptcy, gotten behind on credit card payments or racked up a lot of debt – it is possible to rebuild your credit. Here's how.

Check the Credit Report

Your credit score (often referred to as your FICO score) provides a snapshot of your credit status. It's determined by a variety of factors that can be broken down into the following categories:

  • Credit History – How long have you been using credit?
  • Payment History – Do you have a history of paying on time?
  • Credit Amount – How much do you make and how much do you owe?

So, the first thing you should do is assess the damage by looking at a current credit report issued from one (or all) of the three major credit bureaus: TransUnion, Equifax or Experian. Under the Fair and Accurate Credit Transactions Act, every American has the legal right to receive one free report from each one of the companies per year, which will save you some money on processing fees.

Check over your credit report with a fine-toothed comb: Verify that the amount you owe on each account is accurate. And look for any accounts you paid off that still show as outstanding. If something seems incorrect or you are not sure of any items, then it is your right to contact the credit agency in writing and ask them to investigate the issue and make an amendment. The Federal Trade Commission recommends sending your letter via certified mail and requesting a return receipt so you know the bureau received it. According to the FTC, companies typically must investigate disputes within 30 days of receiving a correction request.

Pay special attention to any recent inquiries that you did not authorize. Before a creditor approves you, or someone pretending to be you, for an account, they will make an inquiry which will be noted on your credit report. If there are inquiries that you did not authorize, notify the credit bureau immediately.

Checking your credit report on a periodic basis, at least annually, is a good way to catch any instances where you might be the target of identity theft – or the credit bureau has accidentally mixed up your history with someone similarly named (it happens more than you'd think). If you are concerned about others accessing your credit report without your permission, you can freeze it, which will limit who can access the information and under what circumstances. If you think you are a victim of identity theft, contact your local law enforcement authority immediately.

Contact Your Lenders

It is always best to contact your lenders, creditors or services providers (such as your utility company or physicians) as soon as possible when you face financial difficulty so that you get their help to stay current on your accounts. Collection agencies and legal fees cost lenders a lot of money, so they are often open to negotiations, which are free. Call, email or write to explain your financial situation (for example, if you have experienced a job loss or unexpected set of expenses due to medical emergency). Discuss a new payment plan and make a good faith payment to begin improving your account status.

Assuming unemployment isn't the issue, job stability is a good indicator to lenders that you will make good on your debts. If you have a spotty resume, make the choice to stay in your current position for at least a year or two to build lenders' confidence. Of course, don't hesitate to take a new position if it comes with a sizeable bump in salary.

Pay Early and Often (or at Least, On Time)

Once you know what you have to work with, make sure that all of your accounts are current, and up to date. Were you a little tardy paying that MasterCard bill last month? Well, this will go on your credit report and lower your credit rating. The longer and more often you do not make bill payments on time, the lower your credit rating will become. And many lenders won’t give credit to people with a history of recently missed payments on other credit accounts (with "recently" translating to two years back). Missing enough payments that your account is turned over to a collection agency is another sure way to tank your score, not to mention limiting your access to affordable credit – or make it cost more than it should.

Credit reports record your payment habits on all type of bills and credit extended, not just credit cards. And sometimes these items show up on one bureau's report, but not another's. Old, unpaid gym dues that only appear on one report could be affecting your score without you even realizing it.

A full one-third of your score depends on whether you pay your creditors on time. So, make sure you pay all your bills by their due dates, including your rent/mortgage, utilities, doctor's bills, etc. Keep documentation (like canceled checks or receipts) to be able to prove that you made timely payments.

The Fair Isaac Corporation, which calculates FICO scores, recommends signing up for payment alerts if your lender makes them available. You’ll get an email or text message announcing the impending due date, making it harder to forget a payment. Another approach is to set up automatic drafts from your bank account.

You don't have to pay your bill in full to have your payment counted as on-time; you only have to pay the minimum (though that isn't there to do you any favors – it's there to keep you in debt: You'll be paying lots of interest, and paying off your balance for years). However, if it's all you can afford, you're better off making the minimum payment on time than not making a payment at all. The important thing to remember here is that a consistent history of on-time payments will cause your credit rating to rise.

Pecking Payment Order

When you do use your cards, try to pay them off as soon as you can (you don't have to wait for the statement in the mail but can pay online anytime). When you have the extra cash to pay down your outstanding balances, focus on the cards that are closest to being maxed out, to benefit your credit score the most. Next, zero in the credit card balances that are higher than 50% of your credit limit. Borrowers who have used up more of their available credit are considered higher risk.

That being said, if those are the cards with the lowest interest rates, perhaps because you took advantage of a low APR balance-transfer offer, the savings you'll achieve from paying off your highest-interest-rate debt first may be more important than improving your credit score.

When one card is paid off, take the payment you were making to the paid-off card and add that to the next card.

Don’t Open Too Many Accounts

The number of credit accounts you have open is also important to control. Credit cards are easy to open. Almost every store has a quick, convenient way to get you a new card. Attractive incentives, such as big discounts on purchases the day you sign up, add to the temptation. If you shop in that store often, it may be worth getting its card; otherwise, resist the urge.

It's not just that the new plastic can encourage you to spend. Having too many cards can hurt your credit score. Credit-lending institutions will look at the total amount of credit you have available to you. If you have 10 credit card accounts, and you have a $5,000 credit line in each account, then that will amount to a total of $50,000 in potential debt. Lenders will take a look at this potential debt load – as if you were to go out and max all your cards tomorrow – before considering how much they will lend you. They also worry about whether you will be able to meet your financial obligations.

What's more, each time you apply for credit, the potential lender will check your score. Each time your credit is checked, other potential lenders worry about the additional debt that you may be taking on. Sometimes, the act of opening a new account, or even applying for one, can lower your score; having lots of recent inquiries on your credit report dings your score temporarily. So don't apply for cards often, if you want to raise your credit score.

Don’t Close Credit Cards

A good idea would be to keep three to four credit card accounts open, but only use one or two of them; put away or cut up the others. Once you have paid off a card, though, keep the account open, even if you don’t want to use it anymore. Closing a credit card will lower your credit score, even if you always paid it on time and did not have a balance. If you desire to close a card due to its high annual fees, try calling the credit card company and ask them for a downgrade to one of their free cards. This allows you to maintain a longer history with the company, which is important for a healthy credit score. The credit card company will report to the credit bureau that you have a good record with them, which will increase your credit rating.

Closing out delinquent accounts or those with a history of late payments can also help, as long as you've paid them off in full. Because history is important, if you do decide to close a few more accounts, close the newest ones first. The length of your credit history is 15% of your score, so even after you've paid down your balances, keep your oldest cards open. Be sure use these cards to make occasional purchases (then pay the bills in full), so the card company won't close your account for inactivity.

One Card to Consider

If you do need more plastic, experts advise applying for a secured credit card, where your balance is tied to money held in a specified account. These cards often come with high fees, a high interest rate and a low credit limit, but they report your repayment history to the three major credit bureaus monthly. Use your card to build up a positive credit history and wait: as you make on-time payments, your credit score will improve after a few months of steady use.

If you opt for this method, screen the card issuer carefully, as the annual or application fees among different providers may vary (this is also true of unsecured credit card providers). Try to find a credit issuer that does not charge an application fee and allows you to convert your unsecured card to a regular credit card after 12 to 18 months of established payment history, and reports your history to all three credit bureaus. After all, if the issuer doesn't report to the credit bureaus, the card won't help build your credit history.

Increase Your Credit Limit

There’s a way to boost your credit score that doesn’t involve paying down debt or any of the other more traditional credit score boosting tactics. Since credit scores are determined, in part, on the difference between your credit limit and the amount of credit you use, ask for a higher credit limit. Your chances of increasing it are likely better than you think. Of those who apply for a higher credit limit, 8 out of 10 are approved, according to a recent Bankrate Money Pulse Survey. While it helps to be over 30, odds are good for all adults. To avoid having your credit diminished by asking for a higher limit, ask for the highest credit line increase that won't trigger what's called a hard inquiry. (For more see Credit Score: Hard vs. Soft Inquiry.)

By increasing your credit limit, you automatically increase the spread between the amount you are allowed to borrow and the amount you actually do. The larger the spread, the higher your credit score.

The Credit Utilization Ratio

This spread, known as the credit utilization ratio, is expressed as a percentage. For example, if the limit on your MasterCard is $5,000 and you have a balance of $4,000, your utilization ratio is 80%. If you request a credit line increase and your limit goes up to $10,000, suddenly your utilization is just 40%.

Obviously, the higher the percentage, the worse you look. Experts have long said that using 30% of your available credit is a good way to keep your credit score high. More recently, that recommendation has been reduced to 20%. In the $5,000 limit MasterCard example above, 30% utilization would represent a $1,500 balance. Boosting your credit limit from $5,000 to $10,000 would allow for a $3,000 balance and still maintain 30% utilization. (This, of course, is just an example: It’s not likely you would get a 100% increase in your credit line. But any amount will help increase the spread and lower the utilization ratio).

A third of your overall credit score is based on the credit utilization ratio across all of your cards. Because of the way credit scoring works, it's better to carry a $1,000 balance on a card with a $5,000 limit (20% credit utilization) than to carry a $500 balance on a card with a $1,000 limit (50% credit utilization). That's why, in discussing payment pecking order, we recommended paying off the cards closest to being maxed out. That's also why you shouldn't terminate accounts; it'll increase the percentage of total available credit that you’re using – and that will reduce your score.

Negotiate a Lower Interest Rate

However, the key to this strategy is obtaining more credit, but not using more credit. In other words, if your limit goes up $1,000, don’t go out and charge half of it. Think of the boost as a way to save money later when you apply for an auto loan, home loan or another form of long term debt where a high credit score will likely result in big savings via a lower interest rate.

While you're at it, ask the credit card company if they could lower the APR on your card. With a lower interest rate, your pile of existing credit card debt won't grow as much every month, and you'll be able to pay down your balances faster.

Diversify Your Credit Types

A good credit score has a mix of both installment debt/credit, such as a car loan, student loan or mortgage, and revolving credit, like a credit card or home equity line of credit. This balance of credit types accounts for 10% of your FICO score, which is significant enough to not be neglected.

Beware of Scam Artists

If you are having troubles paying some of your bills in a timely fashion, then maybe debt consolidation is right for you. (See Digging Out Of Personal Debt.) But tread carefully: This a field ripe with scam artists who rebuild nothing but their own bank accounts. If you are approached with an offer of help to negotiate your debt, make sure that you receive a copy of the "Consumer Credit File Rights Under State and Federal Law" and a detailed contract for services including contact information, stated guarantees and an outline of fees and services before you provide any personal information or turn over any financially-related documents. Ask for references, do online research and keep copies of all paperwork and correspondence in case a dispute arises.

The Bottom Line

The hardest part of getting out of debt and improving your credit score is being patient; you can have an appreciable effect, but it will take time for you score to reflect your efforts. Unless there are major errors on your credit report that you can easily get erased, there is no quick fix for a bad credit score. Often, it takes at least a couple years to go from a low score to a high one.

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