Barry Paperno is a freelance writer and credit scoring expert with decades of consumer credit industry experience, serving as consumer affairs manager for FICO (formerly Fair Isaac Corp.) and consumer operations manager for Experian. He writes “Speaking of Credit,” a weekly reader Q&A column about credit scoring and rebuilding credit, for CreditCards.com. His writings about credit scoring have appeared in The Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.
Dear Speaking of Credit,
I recently got defaulted from a Banana Republic credit card for missed payments. That has affected my credit score, and I am now trying to get back on track.
I recently paid off the remaining balance in full and am looking to cancel this card for good.
My question: Was paying off the remaining balance in full the best decision credit-wise? And what do you recommend for me moving forward? – Daniel
Let’s start with the no-brainer answer to your first question of whether paying off the remaining balance was a good idea. Absolutely!
Despite those missed payments that hurt your credit score, you did right by paying off that card balance, since doing so can:
- Stop additional interest and late charges.
- Prevent a collection agency from entering the picture.
- Start the “credit rebuilding clock” ticking.
However, now that the balance has been paid, whatever you do, don’t close the card. You’ll see why below.
Your second question, looking for a recommendation on how best to move ahead, cannot be addressed quite so simply – thanks in part to your choice of terminology.
What a ‘defaulted card’ means
Usually by the time you default on a card, the card company has:
- Canceled and closed the account.
- Written the debt off as a loss.
- Reported the account to the credit bureaus as a “charge-off.”
Since you imply that the account remains open, my guess is you probably paid it just in time to avoid setting the above wheels in motion. If so, consider yourself fortunate. You now have the opportunity to turn this critical situation around.
On the other hand, the account may very well have defaulted and you may just not yet be aware that it has been closed in addition to being charged off.
Such misunderstandings of where a problem account truly stands are not unusual given the often confusing nature of customer communications and credit reporting policies. We’ll hope this is not the case.
Now, let’s look at both of these possibilities and how best to proceed onward from each.
When a defaulted card is paid in the nick of time
This is obviously your best-case scenario. Instead of closing the account as you’re considering, keep it open and active by making small charges and paying the balance in full each month.
Video: How payment history affects your credit score
This renewed activity will allow you to begin countering some of that past negative credit history with a record of consistent on-time payments and low credit utilization – the amount you have borrowed compared to your credit limits. The lower the credit utilization, the bebtter.
Then, heading into the future, do whatever it takes to avoid a late payment on any credit account.
Whether that means keeping your balance(s) at a manageable level, setting up automatic payments, only charging one or two tiny amounts – cup of coffee or your Netflix bill, for example – or all of the above, make a perfect payment history over multiple accounts your top priority.
When the defaulted account was closed and charged off before you paid it.
Once the card has been closed and charged off you’ve forever lost the option of reopening it to re-establish that good pay history and low utilization.
- Instead, look to any other existing open card accounts that remain in good standing or consider opening a secured credit card that reports monthly to the credit bureaus. A secured card operates much like a regular credit card, except the cardholder makes a security deposit to open the account. Often equal to the credit line, that money assures the card issuer that a borrower won’t rack up a bill and walk away.
- You can alternatively go with both options, as the more “good” cards you have, the more points to your score these score-rebuilding efforts are likely to deliver.
- Along with missing any more payments, what you also don’t want to do over the coming months is apply for any unsecured cards, as your low score will likely lead to denial.
Fortunately, all credit scoring models treat secured cards just like unsecured cards when evaluating their payment history, amounts owed, length of credit history and other sets of scoring calculations.
Many secured cards convert to an unsecured card after one year of responsible use.
How long will rebuilding credit take after a default?
Whatever credit rebuilding challenges lie ahead, you’ve crossed the first, and most important, hurdle – you paid off the debt. For that you deserve a big pat on the back.
Now you can move forward by re-establishing a positive credit picture over the long haul, which is more likely to take two to three years than a few months.
This length-of-time question will depend on many unknowns, including the extent of this and any other similar credit setbacks, and the type(s) of credit you might be seeking in the future.
Credit cards, car loans and mortgages tend to require different scores, income levels and other requirements.
Over the next couple of years, you can get the best handle on your rebuilding progress by monitoring your credit score using one of the many free credit monitoring services, such as those offered by CreditCards.com.
Then, watch as your score regains the respectability it once had.
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