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Six Steps To Restoring Your Credit 

It doesn’t take much.

A few late payments to the mortgage company. A forgotten gas card bill and, suddenly, your once stellar credit rating is wallowing in the mud.

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In today’s faltering economy, where jobless claims are up and home values are down, such scenarios are all too common as a growing number of consumers fall behind on their debt obligations.

Indeed, the number of personal bankruptcy filings hit 822,590 in 2007, up 38 percent over the 598,000 filed in 2006, according to the Administrative Office of the U.S. Courts.

"People are really getting squeezed right now," says Clare Stenstrom, a certified financial planner with New York-based Bourne Stenstrom Lent Asset Management. "The price of food, gas and everything else is way up and too many people think that their credit limit on their cards is their money. It’s not. It’s borrowed money that you have to pay back with interest."

Even a few missed payments can reduce your credit score substantially, making it harder to borrow money from lenders.

Keeping Score

"People don’t always understand the importance of their credit score," says Jeff Blyskal, senior editor for Consumer Reports. "It raises the cost of credit and can keep you from getting loans."

So what’s a credit score?

Your credit score is a three-digit number generated by analyzing your payment history and debt profile.

Banks and credit card companies use credit scores to determine whether to qualify applicants for a loan and, if so, what rate to charge them. The lower your score, the higher your interest rate.

Many landlords these days also use credit scores to determine whether prospective tenants are eligible to sign a lease.

And car and home insurance companies use them to determine what premium they should charge.

What difference does a few points make? Plenty. With the best credit score, you would generally qualify for the lowest interest rate available—say, 6.30 percent for a 30-year fixed rate mortgage. On a $300,000 loan, that would make your monthly payment $1,857.

By comparison, those with the lowest scores today would qualify for a rate closer to 7.90 percent with a monthly payment of $2,178. Over the life of the loan, that's $115,560 more.

Six Steps To Respectability

Luckily, if your credit rating is less than worthy, there are steps you can take to redeem yourself.

First and foremost, start making payments on time. "Paying on time is the most important thing you can do," says Stenstrom, noting payment history constitutes 35 percent of your total credit score.

Another tip: If you don’t have money for a minimum payment by the due date, but will the following week, pay it next week. "Don’t just double up your payment the next month, which a lot of people do," says Stenstrom. "That makes you 30 days late and that will drop your credit score."

Check Your Report For Errors

You are entitled to a free copy of your credit report every 12 months from each of the leading consumer reporting agencies –Equifax, Experianand TransUnion.

So take advantage of it. You can request a copy of your report by contacting the three credit reporting companies individually or request them all for free at www.annualcreditreport.comIf you find any errors, correct them immediately. "If there are things that have been paid but still show up as a collection account, or you find an old judgment or lien you thought was paid, pay off what you owe," says Blyskal. "Get those off your record."

Don't Borrow Money You Don't Need

The average American consumer carries between five and 10 credit cards in his wallet. That makes it easy to get in over your head. It also makes lenders nervous.

"A lot of stores will give you 10 percent off your purchase if you sign up for their card, but don’t fall for it," says Blyskal, noting creditors don’t want to see consumers with too much credit available—even if you’re not using it. "Suddenly, you’ve got another card in your wallet."

Call Your Creditors

If you’re having a hard time making your monthly payments, contact your credit card companies right away.

Though some planners recommend using no-cost credit counseling services to help negotiate lower rates or payments, Stenstrom says consumers can easily do the legwork themselves.

"Don’t talk to the person who picks up the phone – they don’t have the authority to help you," she says. "Insist on speaking with a manager and tell them you’re having financial problems."

Often, she says, the manager will work with you to establish a lower monthly payment plan, freeze the interest owed, or forgive some of your debt altogether. "They would rather get 75 cents on the dollar than have you go to bankruptcy court," says Stenstrom.

Pay Off Your Balances

Next comes the hard part. Pay off what you owe—and don’t incur any new debt.

If you have multiple cards, send in as much as you can to the one with the highest interest rate, while continuing to make minimum payments to your other cards.

Once the highest rate card is paid off, start chipping away at the one with the next highest rate—and so on.

Bringing your credit card balances to zero renders you instantly more creditworthy.

More Steps

Start Using Cash

Stop using credit until you’ve got your financial house in order.

By handing over cold hard cash for every purchase it’s easier to keep track of how much you’re spending on a daily basis.

If you struggle with self-control, try putting your credit cards in a container of water and storing them in the freezer. "If you’re tempted to use them you have to wait until it melts and hopefully by that time the impulse is gone," says Stenstrom.

If you still have trouble saying no, cut them up, but don’t close the accounts. "If you close them and you have a good payment history you’ll loose that," she says.

Create A Budget

It’s good advice for anyone, but for those who are falling behind on their bills, the value of having a budget cannot be overstated.

"If you know what it costs you to live, it’s easier to cut back here and there," says Stenstrom.

There are plenty of ways to find more money in your budget to pay off debt and clean up your credit.

Stop paying more on your cell phone for text service. Drop cable TV. Take lunch to work and print coupons for your favorite products off the Internet.

"If you can’t afford a babysitter, try trading off nights of babysitting with another couple or have your friends over for a pot luck dinner instead," she says. "Get a second job if you have to."

Remember, a poor credit rating may hamper your ability to secure low-cost loans, but it isn’t set in stone.

By putting yourself on a strict financial diet, eliminating credit card debt and making home and auto payments on time, you will not only raise your credit score considerably, but you’ll reduce the amount of interest you pay every month –money you can devote to an emergency fund to ensure you never have to worry about late payments again.