A step-by-step guide to rebuilding credit

What do you do when your credit score only seems to drop? Here's what you might be doing wrong — as well as how to start rebuilding credit.

How important is your credit score? It can have a big impact on whether or not you’re approved for a loan, as well as what interest rate you might end up paying. 

Unfortunately, it can be relatively easy to mess up your credit score. If you miss loan payments or end up with credit card debt you can’t repay, your credit score could drop quickly.

There's good news, though. Even if your credit score is in tatters, you're not necessarily sentenced to a life of high interest rates and rejected loan applications. Rebuilding credit is entirely possible. Here's how.

4 things that damage credit scores (and how to rebuild credit)

Before you do anything else, check your credit score. See a different number from what you expected? Get a copy of your credit report to verify that there are no inaccuracies and that someone hasn't opened an account under your name. You can find your credit report for free with Borrowell or Credit Karma.

If you think your score could stand to be higher, it's time to learn what causes your credit score to drop in the first place. After that, raising your score again is simply about replacing those bad financial habits with healthy ones.

1. Missing monthly payments

The payment due dates outlined in your monthly bills aren't just suggestions; missing credit card payments or getting behind on bills signals to lenders that you're experiencing financial difficulty, which lowers your credit score.

How to repair the damage: make payments on time

It's very important to pay down your debt and make your monthly payments on time — if not the full amount, then at least the monthly minimum payments. If you can't afford to pay a monthly bill, such as a cellphone, call your provider and explain your situation. Usually, they'll work with you to create a reasonable payment plan.

2. Taking on too much debt

While most lenders will limit how much you can borrow, you can still lower your credit score by taking on too much debt within that limit. The drop is due to your debt utilization ratio, which measures your debt relative to your total credit limit. Generally, it's not a good idea to spend more than 30% of your credit limit if you want to keep your credit score high.

How to repair the damage: be mindful of your debt utilization ratio

If you have credit tools that are above the 30% debt utilization ratio threshold, focus on paying those down first. Getting your debt below that threshold will help you start rebuilding credit and give you room to maneuver in emergencies.

3. Facing bankruptcy

If you had a judgment against you, declared bankruptcy, or faced similar financial circumstances, your credit score will drop to a very low level to reflect your creditworthiness to potential lenders.

How to repair the damage: don't open any new accounts

Taking on new debt can be a red flag if you've already over-leveraged your current debt. In turn, this can hurt your credit score. Avoid applying for any new credit cards or types of debt until your credit score has improved.

4. Shortening your credit history

The age of your credit history is an important determinant of your overall credit score, which means that closing your oldest credit account could hurt your number.

How to repair the damage: maintain your oldest account

If you've been on a spending spree recently and you plan to close accounts to avoid future temptation, then good for you! Reducing your available credit is an excellent strategy to avoid future problems with debt. That said, you should keep your oldest credit account open, since the length of your credit history has an impact on your credit score. Rather than cancelling that student credit card you've had for 10 years, perhaps convert it to a rewards card or something similar instead.

Your credit score is an important part of your financial profile, but it's also fluid: it rises and falls depending on how you manage your debt. Your credit score may be low now, but if you follow the tips above, you'll be well on your way to boosting your score.