I was chatting to my friend Sylvia yesterday and we were talking about her current credit situation. Frankly, it didn’t sound so great. She’s had a hard time in recent years and her credit – unfortunately – has suffered. First, she went through a really hard divorce and then she lost her job with the recession and all. Both incidents had a knock-on effect on her credit rating as she shared a lot of her expenses with her husband.
Also, part of what caused stress in their marriage were finances as she soon found out he wasn’t’t the best at paying their bills on time. When she went back to work after having their son, her hubbie agreed to take care of all the bill payments. Now, in retrospect, she wished that she would have handled them herself. Then, when she had to find a place on her own as well as take care of her little one even when she lost her job, she found it very tough. She had to take out a loan and had a really hard time paying it on time. As a result, her credit rating suffered. This situation isn’t a very unique one in this day-and age…many people across Canada are experiencing similar issues in managing their bills. A lot of these issues were somewhat unavoidable since she was put in an awkward situation and had to act quickly to get it sorted. Sylvia’s tried not to let it get her down and, like me, has vowed to get her finances in order this year by making some changes. Hopefully this time next year we can both celebrate our debt-free lives.
When I spoke to Sylvia, I asked her about her poor credit and what her plans were to get it back on track. She said that she heard that all it takes is 4 steps to get things started. Here’s what Sylvia plans to do….
Step 1 – Create a spending plan
Now that Sylvia has a lot of the emotional aspects of her divorce and loss of job behind her, she can start to think rationally about things. She realized that one of the key reasons that so many people end up with credit problems and low credit scores is because they haven’t made a spending plan, or they haven’t followed it. In Sylvia’s case, she doesn’t have one and she was quite honest about that. Hers was supposed to be done by her husband but it didn’t seem to exist. When they split up, she tried but wasn’t in the right frame of mind as was in survival-mode. A spending plan really is another name for a budget and in this blog, I’ve talked a lot about why that’s important and some tools that can help. I mentioned these to Sylvia and she’s going to build some of those tips into her plan. She also mentioned that she plans to allocate some money every month to a separate savings account. She felt that although she’s still in debt, she still wanted to save for an emergency if there ever was one.
Step 2 – Deal with existing debt
After developing her plan, Sylvia knew she had to start significantly paying off her balances. Sylvia hadn’t maxed her cards out yet but she was close to exceeding 75% of her limit, which should ring alarm bells for many of us and should signal us to pay down the debt as quickly as possible. What I was surprised to find out was that when you use 75% or more of any of your credit limits, it negatively impacts your credit score. Paying your credit cards down to below 50% of their limits will really help your credit score the most. She felt that it would also help her budget better since she wouldn’t be paying as much interest.
Step 3 – Pay bills on time
This is one of the areas where Sylvia was failing on largely and led to her issues with credit. She was really honest with me and said that she forgot when a number of bills were due and ended up being late. She knew that if she truly wanted to rebuild her credit, she needed to pay them on time. This is the easiest way to restore and maintain good credit—by making payments as agreed. Sylvia decided to add reminders in her calendar now three days before the bills were due so she could send the payment via online banking in time. This way all was paid and there wouldn’t be any issues in her track record.
Step 4 – Re-establish credit
Although Sylvia really wanted to just cut up all her credit cards and just focus her efforts on paying off her debts, I told her not to. Remember if you do take this approach and you pay all your debts off, you’ll end up having no active credit and effectively a zero rating. This isn’t good either and can harm you down the road when you inquire about a mortgage or other loan. So, Sylvia decided that she’ll keep one active but always ensure that she uses it wisely. It’s always good to have a credit card too in case you have any additional insurance coverage on the card or even points you can benefit from. The goal here is to re-establish your credit rating but also re-establish your relationship with credit. Both should be positive, not negative.
Although many people in Sylvia’s situation would feel a bit uneasy about re-establishing credit, she seemed excited. Her attitude was a good one. Whether we like it or not, building a positive credit score is a reality for all of us in Canada. Taking the time to take these first 4 steps, can help you recover from a bad credit situation – just like Sylvia is doing now.
Good luck!
