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Credit Rebuilding Guide - Everything you need to know

So, you have been tardy with paying your credit card bills. It’s not your fault, you say; you have encountered expensive times. Or maybe, you had no idea that paying only the minimum amount due affects creditworthiness. It is possible that your low credit score is not even your fault: It could be that you ended up branded as credit-unworthy because of a dispute with a prior credit provider. All said and done; however, you’re left holding the ball, or in other words, wondering, “how to rebuild my credit score?”

The first thing you need to know is that rebuilding your credit score is possible. Many people have accomplished the feat of rising from the ashes of credit “unworthiness” to obtaining a fresh line of credit. We’ve brought the answer to your question, “how to rebuild my credit score,” but you will need to bring your share of diligence and patience. With that said, let’s dive in:

Step 1: Know where you stand

There’s no point in asking, “how can I rebuild my credit score” if you don’t even know your credit score. You might have found out about the fact that you have a low credit score because a lender - or several - rejected your credit application. However, it is better to get an idea of your score. You can ask one of the lenders who turned you down or alternatively check your credit score directly on the CIBIL website.

Step 2: Roll out the (proverbial) duct tape

Armed with your credit score, you have a baseline and can begin working towards notching your credit score upwards. You now have a clear starting point and a clear goal, namely 750, which is the bare minimum for a majority of lenders, both banks and non-banking financial institutions. Here are three measures that can help rebuild your credit score:

● Settle existing debt on time

There is a good chance that you found out about your low credit score while applying for a new credit card to supplement the credit available on existing cards. If this is the case, you are in a better position to rebuild your credit score than most because you have a ready line of credit. This ready line of credit can be used to prove your creditworthiness because if you start paying bills on time with a vengeance, your score will start improving automatically. However, you will need to make on-time payments a habit, or a regular feature. Paying your credit card bills sometimes on time and missing them once in a few months will not help. Remember that delayed payments negate the benefits made by previous on-time payments.

● Pay off the entire sum due

Also, given the situation that you find yourself in, you will need to pay not just the minimum amount due, but the whole amount due as far as possible. Or at least as much as possible.

The minimum amount due is what allows you to continue using the card in question, failing which the credit provider will cancel your card. That said, frequently paying only the minimum amount due can negatively impact your credit score. You are setting yourself up for a more challenging situation in the future because you pay compound interest - or interest on interest - for the unpaid amount.

For example, let's assume you have used Rs 12,500 of credit and the minimum amount due is Rs 2,500. You only pay Rs 2,500.

The next month’s credit card bill will include the unpaid amount, that is Rs 10,000 + interest (at about 3-4%) which adds up to Rs 300 to Rs 400. Now you owe Rs 10,400 instead of Rs 10,000

You can imagine how this compound in the long run and with larger amounts. You end up paying a far higher total in the long run. It is no surprise then, that so many people struggle to pay off long-term debt, or debt that they have procrastinated with. Break the vicious cycle and start paying off the whole amount. Don’t get paid enough to pay off the whole amount? See what expenses can be shed or postponed so that you only use as much credit as you can regularly and comfortably pay off.

● Minimize credit utilization

This might feel like a slap in the face if you’re asking “how to rebuild my credit score” because the credit you have is proving insufficient, which is why you’re looking for more credit in the first place. However, such are the rules of the game. A high credit utilization contributes to a low credit score and vice-versa.

For example, if your credit card offers a limit of Rs 4 lakh, try and use no more than Rs 40,000 as part of your strategy to rebuild your credit score. Yes, we are indeed recommending that you use no more than 10% of your credit limit when your credit score is ailing. Some perspective: even when you are considered very creditworthy, most experts will tell you to use no more than 30% of your credit limit.

Step 3: Offer collateral

If lenders are concerned about your ability to make good on your debts, you might want to offer them some assurances. In the world of credit, this means choosing secured options. You will need to park capital upfront with the lender, and the volume of capital deposited is generally equal to the amount of credit you will get. In other words, the deposit amount corresponds to the credit limit.

Why would you bother with depositing an amount and then spending your own capital? Why even bother with credit if you already have capital? Well, because it is a route towards obtaining credit in the future.

You can similarly opt for a secured loan, where receive a loan against your fixed deposits or shares. Keep in mind, however, that if you are unable to pay you end up surrendering the investments against which you obtained the credit.

This is also a good option for freshers who have no credit history and a low salary, resulting in wary lenders. (No credit history is also seen as problematic because the lender cannot judge your ability and diligence with regards to making good on your debts).

Step 4: Rope in a third party

When all else fails, you might need to tap into the trust of a friend or relative. You have two options in this category: you can get added to a third party’s credit card as an “authorized user”, or alternatively, they can co-sign your credit application.

The pros are obvious; you will reopen your line of credit. However, the risk of damaging your friend or relative’s credit score is very real, especially if you have a way of burning through available credit. Be honest with yourself and the third party in question.

Top tips: Spending within your means

Being responsible with credit is often the same as spending mindfully. Here are some tips:

1) Create a Wishlist of spending, including items you desire, holidays, and so on. Then segregate these into needs and wants and maybe give your wants a hierarchy.

2) Pay off compulsory dues like rent/ lease, children’s fees, own or parental medical expenses, prior credit card debt, and dues related to monthly investments before allowing for leisure spending

3) Trick your mind:

- Look at your outstanding credit amount every time you are about to make a purchase

- Ask yourself how long it would take you to earn/ repay the amount you’re about to spend

- Put off the purchase; promise yourself you will come back for the item (if you’re shopping offline, you will return only if you really need it; if you’re shopping online there is a chance that adding it to your cart will provide sufficient dopamine release and you will not need to purchase the item)

- Don’t stock up on clothes and accessories. Buy items just before an event or just before they are required

4) Play bad cop with yourself and ban spending if you recently overindulged

5) Extend that intermittent fast to your spending too. Have 18 days off (spending); 6 days on (spending) sort of arrangement with yourself

6) Don’t use reward points as an after-thought just before they expire. Use them to reduce your spending. Maybe you don’t need to buy that new smartphone on credit; your points might be able to cover it.

The takeaway

Rebuilding a credit score might take a few years of diligent payments, controlled spending, and patience, as your score inches towards improvement. You will see results slowly but surely and in the long run, you will also have developed the good habit of becoming a more mindful spender.