How To Build Your Credit After Debt Settlement

Disclaimer: We are not qualified legal or tax professionals and are not giving advice. Always speak with a qualified professional before making any legal or financial decisions.

Pacific Debt Relief is not a credit repair organization nor does our program aim to improve your credit score. The information below is for educational purposes to help consumers make informed decisions as it relates to credit and debt.

Rebuilding your credit after going through debt settlement may seem daunting, but it's far from impossible. With a strategic approach and disciplined financial habits, it's entirely feasible to restore your credit score and regain financial health.

In this guide, we'll walk you through 10 essential steps to rebuild your credit effectively, from regularly monitoring your credit report to leveraging credit-building tools.

Each step is designed to address specific aspects of your credit profile, ensuring a comprehensive recovery plan. Let's embark on this journey towards financial resilience together

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How Debt Settlement Affects Your Credit Score

When you decide to settle your debt, there are a couple of factors that will negatively affect your credit score. First, your bills are probably being paid late, or they might not be getting paid at all, so those late or missing payments are reported to the credit agencies, affecting your score.

Second, your debts are often reported as “settled” and that typically lowers your credit rating a bit. If you do not pay your debts, they may be charged off (sold to a third party), and that affects your rating as well.

Don’t despair. There are several steps you can take to repair your credit rating. We’ll look at each one in no particular order. In fact, you can do most of these simultaneously.

Credit Repair

Credit repair involves getting copies of every credit report and fixing any errors they may include. There are three main agencies: Transunion, Equifax, and Experian, and several smaller companies. Start with the big three.

As you receive copies of your credit report, check to see how your settled debts are labeled. The hit to your credit is worse if they are ‘charged off’ instead of ‘settled charge off.’ It will take some time, effort, and letters to get this changed, but it can be done. Once your debts are correctly labeled, you may be able to request that settled accounts be removed from your credit report.

If there are errors, dispute them. Occasionally, old accounts are not removed from your credit score. For instance, if you had a foreclosure more than seven years ago, it should be removed. Correcting small errors can help improve your scores fairly quickly.

You can get one copy free once a year from annualcreditreport.com

Pay Bills On-time

Pay your bills in full and on time. This simple and very important action is worth roughly 35% of your credit score! Timely payments mean that you are using credit responsibly and that makes credit agencies very happy. Set reminders, ask to have due dates changed to more financially advantageous dates, maintain a budget – do whatever you need to show that you are being responsible.

Secured Credit Cards

If you’ve gotten in the habit of overusing your credit card, take out a secured credit card. These cards have a credit limit backed by an upfront cash deposit you make before receiving the credit card. If you miss a payment, it comes out of the cash reserve. If you make the payments in full, it improves your credit report. Plus, the discipline will help you maintain a budget.

Calculate Your Debt-to-Income Ratio

The Debt to Income Ratio (DTI) is figured by dividing your monthly debt payments by your gross monthly income. The math is relatively simple.

Front-End DTI: Take your mortgage (principal, interest, insurance, property tax) or rent costs and divide by your gross monthly income – the entire amount you make before taxes are taken out. Multiply that number by 100 to get a percentage. Your front-end DTI should be less than 31%.

Front-End DTI Example

$1000 mortgage/ $1500 income = .66 x 100 = 66%

Back-End DTI: Add all your monthly debt payments including rent/mortgage (property taxes, and insurance payments), car loan/lease, revolving and installment credit (credit cards), and legal liability payments like child support, alimony, and tax payments. Divide this sum by your gross monthly income and multiply by 100. Your back-end DTI should be less than 44%.

Savings to Income Ratio: Add together all your monthly savings such as retirement, investment, and regular savings plans by your gross income. Multiply by 100. Your STI should be 10%.

Monthly Cash Flow: add together all monthly expenses, divide that by your gross income, and multiply by 100. This number should be 100% or less. If it is more, you are spending more than you are bringing in.

Once you have these four numbers, you can see where you need to make adjustments to live within your means. This fairly simple math will help you to improve your credit rating indirectly.

How Long Does It Take to Rebuild Credit?

How long it takes to rebuild your credit and improve your credit score after debt settlement depends on how your credit was before you started the debt settlement program. If your credit is thin (not much on it) or poor, it may take two years to see improvements, if you use your credit wisely and pay your debts on time.

Should I Settle or Pay Debts in Full?

If you can, always pay your debts in full. If you are in debt for more than $10,000 of unsecured debt and you are having trouble making even minimum payments, settlement may be your best possible option.

Consider a Credit Builder Loan

In addition to a secured credit card, a credit builder loan can help establish payment history. These loans function differently than regular loans. The loan amount is held in a savings account while you make monthly payments. Payments are reported to Experian, Transunion, and Equifax. After completing monthly payments over 1-2 years, you receive the money that was held in savings.

Credit builder loans avoid the risk of overspending that comes with credit cards. And your payment history helps build your credit profile. Some companies that offer credit builder loans include:

• Self Lender
• Credit Strong
• SeedFi

While interest rates and terms vary, aim for loans that charge 15% APR or less. Paying on time is crucial, so make sure the monthly payment fits comfortably in your budget. Credit builder loans take discipline, but are affordable ways to establish good payment history.

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