Life After Debt Settlement: Rebuilding Your Credit

When using the debt settlement process to resolve excessive debt, your credit score takes a hit.

That’s the trade-off for thousands (or tens of thousands) of debt relief without filing bankruptcy.

Anyone claiming you’ll have good credit immediately afterward isn’t being straight with you.

There’s no free lunch. Any time you settle debt for less than what you owe — whether via debt settlement or bankruptcy — your credit score will incur some damage. I’ve worked in the financial industry over 10 years and this is how the system works.

Now for the good news …

It’s not the end of the world. You can live a perfectly normal life with less-than-perfect for a few years.

However, if you want to buy a house or car in the future you are going to need a decent credit score.

So let’s take a look at life after debt settlement and the steps you can take to restore and rebuild your credit.

Rebuilding Your Credit: The Initial Steps

Beware of the rebound.

Just like when you break up with a boyfriend or girlfriend there’s a sub-conscious tendency to get right back in a similar relationship with someone new. Same phenomenon happens with finances.

Don’t rush back into anything. Take a moment, smell the roses and feel what it’s like not to have all that debt hanging over your head.

Reflect on spending habits or behaviors that might have contributed to your prior financial challenges, then make it a point never to repeat them.

As they say, awareness is half the battle.

After you’ve completed your financial autopsy, it’s time to implement some lifestyle adjustments so you don’t end up in another painful financial predicament:

• Pay cash. Cash is king. Play a game with yourself and only buy stuff if you have the cash in your pocket. Otherwise, don’t buy it. When paying with a credit card you don’t “feel” the exchange of money for goods or services because you physically don’t pay with paper money or coins. Therefore, there’s a tendency to overspend and/or over-purchase. Studies show that people spend more when paying with credit cards as opposed to cash.
• Use the “3 day rule”. This rule applies to major purchases — things that cost hundreds or thousands of dollars. The 3 day rule goes like this … before making any major purchase, force yourself to wait 3 days before proceeding. If you still want or need that thing 3 days later then go ahead buy it. However, what you’ll find is many times the initial euphoria wears off in 3 days and you don’t end up buying it. A financially successful acquaintance share this concept with me years ago and it’s saved me a TON of money since then.
• Question everything. Do you really need that latte on your way to work each morning or can you survive with a fresh-brewed cup of coffee at home before you leave for work? Is that $4,500 mountain bike really 7 times better than the one for $750? Is it possible to downgrade your deluxe cable TV plan to the standard plan and save yourself $50/month ($600/year) … especially since you watch the same 10-12 channels 99% of the time? When’s the last time you reviewed your cell phone plan? If it’s been a few years, I bet you can find a less expensive plan with the same or better features. If you stop and look around, there’s plenty of places you can trim the fat resulting in little-to-no effect on your standard of living.
• Start saving. Get in the habit of socking away money. You’ve probably heard the stat that 40% of Americans don’t have $400 in the bank for emergency expenses. Don’t be one of them. Create a secret stash (i.e. cash in a coffee can) for emergency purposes. With every paycheck or with birthday money, throw a $20, $50 or $100 bill in there. And do not touch this money unless you absolutely need it. It can accumulate faster than you realize. Saving money gives you peace of mind knowing won’t freeze to death if your furnace goes bad because you now have cash on hand to buy a new one.
• Do it now. Start making adjustments and create new financial habits *today*. Like as soon as you’re done reading this article. I’m not exaggerating. Don’t let your mind trick you into doing it “later” because later never happens. Begin immediately even if it’s a baby step. Nothing changes unless you recalibrate your mind, then take action.

Now that we’ve covered the pre-game (and important) material, let’s focus on actionable steps toward rebuilding your credit score.

What’s Considered A Good Credit Score?

Each of the 3 major credit reporting bureaus (Equifax, Experian and TransUnion) has their own credit scoring formula. But generally speaking, credit scores range from 300-850.

Here’s what your credit score means:

• Excellent credit: 750+
• Good credit: 700-749
• Fair credit: 650-699
• Poor credit: 600-649
• Bad credit: 600 or less

According to Experian, the average credit score in the U.S. in 2019 was 703. 59% of Americans have a credit score of 700 or higher. The 5 states with the best credit scores are MN, ND, SD, VT and WI. The 5 states with the worst credit scores are MS, LA, AL, TX and SC.

The Fair Credit Reporting Act (FCRA) entitles you to 1 free credit report every 12 months. To request a free copy of your credit report, visit www.annualcreditreport.com.

Getting a free copy of your credit report is step # 1 in attempting to repair your credit.

How To Rebuild Your Credit Score After Debt Settlement

When you begin the credit restoration process, don’t panic or get depressed if your initial score is low … because it probably will be.

Remember, you just concluded a difficult chapter in your financial life and your credit report reflects that.

Your credit score isn’t going to be fixed overnight. So just relax and accept that it’s going to take some time.

But that doesn’t mean you have to sit idle and do nothing. There are steps you can and should take to try and nudge the credit repair process forward.

I recommend a two-part approach:

Part 1: Begin Re-Establishing A Good Credit History

A big component of a credit score is your payment history on outstanding debts. Lenders want to see you making consistent monthly payments over a period of time.

However, after settling your debts, your previous credit card accounts are now closed. Therefore, you’re going to need one or more new credit cards.

But who’s going to give you a credit card with bad credit?

It’s a catch-22.

Fortunately there’s something called a secured credit card. They’re designed specifically for people with poor credit.

The way secured credit cards work is you put down a deposit equal to your credit limit. This way the bank is protected. If you don’t pay, they take your deposit.

Start by using your new secured credit card to make normal, routine purchases. Then pay off your balance in full each month so you don’t incur any interest charges. This demonstrates making payments on time and most importantly you don’t accumulate debt again.

After sufficient time has passed (the time period varies from bank to bank), you can request your initial deposit be returned and transition to an unsecured credit card. You might be able to get your available credit limit increased as well.

Here’s an excellent resource for anyone looking for an unsecured credit card.

To accelerate the process, get 2 or 3 unsecured credit cards and use them simultaneously. Just make sure to pay the entire balance off immediately each monthly.

In addition to obtaining one or more secured credit cards to re-establish a good credit history, you can become an authorized user on someone else’s (usually a spouse or family member) credit card. The bank is protected because if you don’t pay, the main account holder is responsible for the debt. Even though you’re not the main account holder, as an authorized user of the account your payment history will show up on your credit report which helps you re-establish a good credit history.

Part 2: Contact The Credit Reporting Bureaus

The Fair Credit Reporting Act (FCRA) states that a derogatory item may stay on your credit report for up to 7 years.

Notice, it doesn’t say that it must remain on your credit report for 7 years. It just says that it may stay on your credit report for up to 7 years.

The FCRA also states that a consumer has the right to dispute items on their credit report And if the creditor or collection agency does not confirm the accuracy of the item being disputed (or if the creditor or collection agency fails to respond), the credit reporting bureau is supposed to remove that item from a credit report.

In a nutshell, I’ve just outlined the philosophy behind getting derogatory items removed from your credit report.

Invoking the dispute process is completely legal and within your right as a consumer. Best case scenario, the creditor or collection agency ignores your request to verify the accuracy of a derogatory item and the credit reporting bureau deletes the item(s). Worst case scenario, the creditor or collection agency says your derogatory item is legit, and it remains on your credit report.

PRO TIP: After you complete the debt settlement process, it’s recommended that you wait 3-6 months before you contact the credit reporting bureau to dispute any derogatory items on your credit report. Reason being, after your account is settled, it might take a few months before your account is permanently archived (or purged) from the credit or collection agency’s system. Then when you dispute the validity of a settled account, there’s a good chance the creditor or collection agency won’t invest the time or energy to retrieve the necessary info (if it hasn’t already been deleted) to verify the existence of your account, and that derogatory item will probably be removed from your credit report.

The dispute process described above isn’t rocket science, so you could do it yourself if you wanted to. But fair warning, it’s a meticulous and time-consuming process that might require persistence and multiple follow-ups.

For that reason, we recommend hiring a reputable firm to do this for you. The company we recommend is Lexington Law Firm. They have this process worked out to a science and their fees are very reasonable. Although there are no guarantees, I believe you have a much better chance of success enlisting their services than trying to do this on your own.

How Long Does Credit Repair Take?

It varies from case to case. Some of the factors dictating how long the credit repair process are:

• How much damage and how many derogatory listings appear on your credit report. The greater the volume of stuff needing to be cleaned up, the longer it might take.
• Are you attempting to repair your credit via the DIY approach or are you hiring a credit repair firm to assist you. Repairing your credit is a slog and taking the DIY approach might extend the timeframe due to procrastination or not knowing the proper steps to take.
• A little luck. Some creditors may fight you when attempting to repair your credit, others may not. If you’re fortunate enough to have derogatory listings from creditors that don’t feel like pushing back, the credit cleanup process might go faster than expected.

It’s impossible to say exactly how long the credit repair process will take. I’ve had clients complete the debt settlement process and they’re able to qualify for a home mortgage in less than 3 years.

As long as you don’t incur a bunch of debt and get into financial trouble again, your credit will gradually improve on its own without you lifting a finger.

But generally speaking, your credit score will improve quicker if you are proactive rather than passive.

Worst case scenario, the Fair Credit Reporting Act (FCRA) states that 7 years is the longest amount of time a derogatory item may stay on your credit report. In practice, however, our clients usually tell us their credit score gets back to a decent level within just a few years.

UPDATE: In January 2020, the Comprehensive CREDIT Act passed the U.S. House Of Representatives. Among the many problems this bill addresses is the amount of time a derogatory remains on your credit report — changing it from 7 years to 4 years (and changing it from 10 years to 7 years for bankruptcy). Unfortunately this law won’t get enacted until it passes the U.S. Senate. 🙁

Conclusion

When you complete the debt settlement process, don’t lose the forest for the trees.

Your primary objective was to obtain debt relief without filing bankruptcy — not to maintain perfect credit. That’s the short term trade-off you made. For most people with a mountain of debt, that’s a trade-off they’ll gladly accept.

At the risk of sounding like a broken record, I’ll say it again … you can live perfectly fine with less than perfect credit for a few years. It’s not the end of the world. If anything, it forces you to settle things down financially.

If you follow the recommendations above, and don’t get into debt again, there a very good likelihood of rebuilding your credit to a respectable level in just a few years — and with a little luck, perhaps sooner.