Ditching My Ex Wrecked My Credit. What Now?

Dear Paco,

I am low income, an artist who gets paid a bit from art and some from a part time job. Sometimes the art income really covers the gaps, sometimes less so. My ex-boyfriend was a tyrant about money. He would yell at me over not making enough and even demanded my paychecks as soon as I got them. His parents once gave him 10k intended to buy cars for both of us, but only $1800 of it reached me in the form of a total lemon.

The relationship was unhealthy and it became clear I had to leave behind the life I was living. Unfortunately, his name was on the home title, among other things, and long story short, I walked away with nothing.

I also walked away still carrying $25k in student loan debt, for which I am about 10 years into an Income-Based Repayment (IBR) plan. During this crisis I neglected to rectify my loan payments and I was marked as being late on eight loans for several months. I wasn't paying attention.

For the last five or so years, with housing help from parents and after moving in with my current partner, I have kept my bank account healthy enough and can cover my own expenses — my loans are current. Moving to a rural place has helped me spend my money in healthier ways, such as participating in an organic farm share and cooking for myself. I'm generally super frugal with my small income and rarely go out to eat or to bars. I do occasionally have flashbacks to my ex, so I’m still getting over that and learning to trust myself with money.

But I need better credit. I don’t have a decent car and I need credit to get a loan. However, I was recently denied a basic credit card when I direly needed one to cover a dental bill. (Luckily, my parents loaned me a little bit of money to cover it.)

My current partner is also an artist and has excellent credit that he built over time. It allowed him to invest in a great new car without changing his income level. I see how his responsible attitude towards credit cards really benefits him and that it is possible to achieve on an artist's budget.

I know that I can handle a small line of credit responsibly, but it seems the credit lenders look at my income versus my loan debt and automatically turn me down. It’s been awhile and my student loans have been current for years now. The loans are in two groups, so I could consolidate, but it would wipe my IBR status back to zero. I need other options.

I need to build my credit back up. What else can I do?

Sincerely,

Living In Credit Limbo

Dear Living In Credit Limbo,

I’m so sorry for what you’ve experienced with your ex. And I appreciate you being so open with the challenges that you’ve faced. I hope you’ll recognize your progress in terms of getting your student loans current and finding some financial stability by making changes in your life. You’re off to an excellent start. Although it will take some time, the good news is that it’s absolutely possible to rebuild your credit, which will make more borrowing options available to you in the future.

Start by exploring current banking relationships. Many factors inform the lender's decision when you apply for a credit card. Your income, monthly rent or mortgage, credit score, and credit history are a few. In addition to these obvious factors, there may be another one that you have yet to consider: your current banking relationship. Suppose your current banking relationship is in good standing, meaning you have had an established account and have no history of overdrawing your account. In that case, it may be easier to qualify for a credit card with this institution over others.

Your current bank is an excellent place to start. If you don’t qualify for a regular credit card, ask your banking representative if a secured credit card option is available.

A secured credit card is like a regular one, but you must provide a refundable security deposit to receive a small line of credit. Since these cards are often issued to folks with little or poor credit history, a security deposit offers some protection to lenders. If you manage your line of credit responsibly by making payments on time and not borrowing more than you can afford to pay back, you’ll get your security deposit refunded in full.

The amount of your deposit will depend. While there are some cards available with a deposit as low as $50, that’s not always the case. Typically, your deposit will need to match the amount of credit you’re requesting. So, for example, a credit limit of $500 would require a $500 deposit.

Secured credit cards often come with low limits and high-interest rates, which means they are not ideal for big purchases or carrying a balance (for the record, most credit card interest rates are high, making them less than ideal for carrying a balance). But don’t worry; even with those limitations, you can still use a secured credit card to build your credit. Use the secured credit card to make small, regular purchases, for example, by paying for a weekly expense like gas for a car or for your monthly cell phone bill. Pay the balance in full each month. Paying off the card in full is an important detail, and it’s why you only want to make small purchases that you can already afford to make with cash. Some folks pay their credit cards in full each week, which is another great strategy for managing debt.

Avoid maxing out your credit card and keep your credit utilization low. (We’ll get into more detail about this in the next section.) It’s hard to predict the exact number your credit score will increase by. Just remember that the process requires a bit of time. You might see a significant improvement immediately, but stay consistent to have the biggest impact on your score. Time is on your side.

By understanding how your score gets calculated, you can see which factors have the most leverage and push or pull those levers to your advantage. According to FICO, one of the three major credit bureaus that score your credit, your score is calculated based on five factors: your payment history, the amount owed, new credit, length of credit history, and credit mix. Each factor is weighted, meaning some factors impact your score more than others. The top two factors that impact your score are making payments on time and the amount of credit you’ve used, commonly called your credit utilization ratio.

Here’s how each element is weighted and what it means for your score:

Your payment history is a record of how you've handled paying back the money you borrowed. When you borrow money for a student loan or through a credit card company, each month, the lender you borrowed from reports your payment history to a credit bureau.

Payment history has the biggest impact on your score, so it’s vital to make payments on time each month. You may have noticed when your score took the biggest hit, it was because you skipped or missed payments. And you might have noticed when you started making payments again, your score should have improved. Keep paying on time and with your secured credit card, pay in full, and you’ll see a marked improvement in your score.

Here is a nugget I picked up while working as a debt collector while I was in college: typically, lenders and credit card companies will only report a late payment to the credit bureaus once your payment is 30 days late. In other words, if you’re a day, two days, or even twenty days late on a credit card or loan payment, rest assured knowing that although you might get hit with late fees, your score will only be impacted once it’s 30 days late.

Broadly speaking, amounts owed refer to the amount of debt you carry in total. While this matters, it’s not as significant as your credit utilization ratio, sometimes called debt utilization ratio, on your revolving accounts. Let’s define some of these terms.

A revolving account is a type of credit account where the borrower has a predetermined credit limit and the flexibility to borrow, repay, and borrow again within that limit. Typically, revolving credit comes in the form of credit cards and lines of credit. Compare these types of accounts to installment accounts with fixed repayment schedules, like loans or mortgages.

Your utilization ratio is how much of your total available credit you’re using relative to how much is available to you. And it’s an important measurement because if a high percentage of a person's available credit is in use, that can be an indication that a person is overextended and may be more likely to miss or make late payments.

Here's how you calculate your utilization ratio: (The total balance ÷ Your total available credit) x 100 = your credit utilization ratio.

Let's imagine your credit card limit is $1,000 and your balance is $300, your utilization ratio is 0.3 or 30%. You can calculate your utilization ratio per credit card, but you can also calculate your total credit utilization across all your credit cards.

The lower your utilization ratio, the more positive impact it has on your credit score. One other thing to note is that the other way you can increase this ratio is by getting an increase in your credit limit. While this might not be possible for you now, perhaps it’s a strategy you can leverage in the future. Just note that having more credit available means you’ll have easy access when it comes to getting into debt. Proceed with caution.

The longer you have a good credit history, the better. Two people who have never been late on their payments aren't comparable if you don't consider the length of time. Someone who has never been late over the course of twenty or thirty years seems like a safer bet than someone who has never been late for only one year. Consistency is key.

New credit are new credit accounts. This matters because when a borrower opens several credit accounts in a short amount of time, the lender views this behavior as risky. And it’s especially risky among people who don't have a long credit history.

Unfortunately, financial constraints can cause people to apply for credit more often than those who aren't as strapped for cash. So those who need access to credit more have the tendency to be penalized with this aspect of credit scoring.

However, if you're shopping around for a mortgage or car loan and applying for multiple lines of credit to see who gives you the best interest rate and terms, don't sweat the inquiries too much. The bureaus will see what's happening, and your score should recover once the shopping process is complete and you've locked in a loan.

The type of credit you have is your credit mix. Credit cards and some of the loan types I mentioned earlier, like student loans and a mortgage, are considered your credit mix. Lenders look for a “good credit mix,” which means having both revolving and installment credit because it shows that you’re able to manage the different types of debt.

There are a lot of different banks that offer free credit monitoring as one of their benefits to banking with them. I have several free savings accounts with Capital One. In addition to no-fee accounts, they also offer a free credit monitoring service called Credit Wise. I get email alerts when my credit score changes and when I open up new lines of credit. Check with your bank to see if they provide a free service like this to help you keep an eye on your credit score.

You can also monitor your credit score directly with Experian, using their free credit tool. In the context of missing your student loan payments for a few months, having a service like this could potentially help you catch an oversight before it becomes a recurring issue.

Even though the Biden Administration’s attempt at canceling student loan debt was thwarted by the Supreme Court, the Administration has recently announced student loan modifications that will help borrowers like you. Roughly 804,000 borrowers that have been eligible for loan forgiveness because they have been paying back their loans for at least 20 years, will have their loans forgiven. If you haven’t made enough payments to qualify, income-driven repayment plans are being modified, don’t worry, you can still benefit.

Under Biden’s new SAVE program, some borrowers will have a monthly payment reduced to $0 while also not accruing additional interest. Many borrowers will likely see their payments reduced because the Education Department will be basing payments on 5% of borrowers’ remaining income, not 10%. You’ll also have a 12-month on-ramp period where borrowers who miss payments within that window will not be considered delinquent, reported to credit bureaus, placed in default, or referred to debt collection agencies.

While it’s not total loan forgiveness, these modifications are designed to help borrowers like you.

May your credit score be high and your lending options plenty,
Paco