Congratulations on resolving your debt! No matter how you achieved this feat, being debt-free takes an incredible weight off your shoulders. Now that you’re financially in the clear, you may be considering ways to begin rebuilding your credit. While this is a great next step to completely regain your financial independence, the method you choose is critical. You might see ads on the internet offering quick and easy “credit rebuilding” loans, but beware! These loans could actually put you right back in the hole with even more debt than before.
Credit Ratings After Debt Repayment
In order to clear your debt, you might have considered filing for bankruptcy, a consumer proposal, or a Debt Consolidation Program. While each option impacts your credit score, some are longer-lasting than others.
For example a bankruptcy will stay on your credit report for at least seven years after your debts have been fully discharged, and in the eyes of creditors, makes you a very high risk prospect. (File a second time and it’ll haunt you for 14 years.) A consumer proposal will impact your credit rating for about three years after your debts have been discharged, and can also scare off future creditors. A Debt Consolidation Program (DCP) offered by non-profit credit counselling agencies, like Credit Canada, has the minimum impact on your credit rating of the three options. It generally stays on your credit report for about two years after successfully completing the program, after which your credit rating will likely be rated as a new borrower, allowing you to officially start rebuilding your credit.
Methods for Rebuilding Credit
With your debts paid off, you may be tempted to get a loan or a credit card to help rebuild your credit rating and score. Although you may be able to get one, it won't help improve your credit rating until the required period following debt repayment has passed—two, three, or seven years, depending on the debt solution you chose. But once the waiting is over, here are some credit building options you can consider, along with their pros and cons.
With debts repaid, many people look to credit cards to help rebuild their credit. But it's important to note that a credit card is technically a short-term cash substitute or a high-interest loan. To keep your credit card working like a short-term cash substitute, only use it when necessary and then pay the balance off in full every month. This is the best way to help rebuild your credit while avoiding interest fees and extra charges. If you pay back only a portion of the card, what you owe on the balance becomes a high interest loan, which you'll want to avoid because you'll pay a lot of money in interest and it could put you back into debt.
A secured credit card is another credit building option which can also help keep your spending in check. With a secured credit card, you put a deposit down on the card that the credit card company holds onto in case you default on your debt.
If you're looking for a new car there's a good chance you'll need a loan to pay for it. But if you've already got a car loan, or you have a car that's been paid off and is still in good shape, I wouldn't recommend getting a car loan. First, you'll likely be viewed as a credit risk and forced to pay a very high interest rate on the loan. In addition, this could significantly increase your debt level, which you've just finished clearing up! So unless a new car is absolutely necessary, avoid car loans until your credit score is in better shape.
Some people will take out an installment loan thinking it will help rebuild their credit, but sometimes the interest rate on these types of loans is so high that a person can easily end up in a bad debt situation again. Always check the interest rate on any loan first before agreeing to take it. Remember, the first step to rebuilding your credit is getting rid of your debt, so don't take a huge step back by getting a loan if you don't one.
Guaranteed Investment Certificates
Some installment loans might not actually give you any money upfront. Instead, the creditor will put the money into a Guaranteed Investment Certificate (GIC), which you are then given once the loan is paid back. While the loan is being paid, it's reported on your credit report as a monthly installment loan you are making steady payments towards, which can help rebuild your credit rating. Like installment loans, however, these should be approached with caution. Credit rebuilding loans may have an interest rate of 7-30%, while the interest on a GIC is only 1-2%. In addition, there can be start-up fees of $200-400. If this is the case, the loan would cost you significantly more than the benefits you'll receive.
Credit Rebuilding Loans
Some lenders might offer credit rebuilding loans (these are the ads you’ll likely see online). These loans often charge extremely high interest rates, some as high as 35-60%. In many (many) cases, these loans do nothing to rebuild your credit and could actually make your situation worse. Conventional lenders, such as banks, will often view someone borrowing from a high interest lender to be in a desperate situation, and as such, will consider them a big credit risk. The more debt you acquire, the more you could potentially hurt your credit, as creditors might consider you to be overextended.
Get Non-profit Help with Credit Building
You’ve worked hard to get out of debt—don’t get back into it! If you've opted to get an installment loan, make sure you're paying a low interest rate. And when applying for a loan, consider your ability to pay off the full amount of the loan; simply being able to make monthly payments could put you further into debt. Do not get a loan unless you can pay off the total amount.
If you’ve paid off your debt and you're looking to rebuild your credit score but you're not sure which route to take, give us a call for a free consultation. As a non-profit and registered charity, we're here to help!