How to Avoid a Credit Catastrophe

Your History is History!

Stephanie Stengele lost her credit history when she got divorced in 2001. "Everything was joint when I was married," says Stengele, 34, an executive assistant in Thousand Oaks, California. "My husband was an authorized user on my cards, and when we got divorced, I closed the accounts to make a clean break."

Because 15 percent of your credit score is based on how long you've had credit, and 10 percent is based on the diversity of your credit portfolio, closing out your accounts -- particularly older accounts -- can hurt your score. Stengele began credit-counseling with a local agency, Easy Credit Relief, and began rebuilding her credit score with secured cards, which are tied to special savings accounts and which prevent consumers from charging more than what's in the account.

Security in Secured Cards

"Once I started adding new lines to my credit report, my score immediately jumped from 680 to over 700," Stengele says. "Three months later, it was 740."

Doug Minor, owner of Easy Credit Relief, says secured cards are a great way to establish credit history, especially for younger consumers who may not know their spending habits yet, because they're relatively risk-free. "Consumers can't hurt themselves with a secured card," he says, "because once they use up the balance, it's done. They can't go into debt."

In addition to using secured cards, consumers with little or no credit can establish credit fast by becoming an authorized user on a friend or family member's card.

A Nasty Surprise

Amber Stubbs wasn't concerned about her credit card debt until she lost her job. "We didn't just get laid off -- the whole company went out of business," says Stubbs, a former contract administrator at an office equipment store in Little Rock, Arkansas. "About 25 of us showed up to work one day, and the doors were locked." Stubbs was just 19 at the time, and her $8,000 credit-card debt sank her credit score to around 570, forcing her to borrow money from friends and deplete her savings.

After six months of unemployment, Stubbs landed a position with Cardratings.com, an online resource for credit-card and scoring information. "Once I had a job, I started paying my debt back and building new credit with secured credit cards," says Stubbs, now 29. "My score is around 690, but it's still increasing. I got out of debt by budgeting and making a plan. The biggest thing is just not to throw your hands up and give up."

Asking for Help

People who get laid off should postpone applying for new credit and contact their card issuers before they miss payments, advises Catherine Williams, an exec at Houston credit-counseling agency Money Management International. "Creditors can put suspension programs in place that might allow you to skip a payment or reduce your payments," she says. "But you have to ask for help before you're late on bills."

Bankruptcy Blues

"In 1997, I founded an auto-repair shop with a partner," says Patricia Fragen of Naperville, Illinois. "It went along swimmingly for about three years before he started taking side work and driving the company into the ground. And since everything was personally guaranteed, the only way I could get out of it was to file for personal bankruptcy." After she discharged "a couple hundred thousand" in credit-card debt through bankruptcy, her credit score sank below 600.

Fragen rebuilt her score by eliminating all but two cards; she set up automatic debit payments on one, and overpaid a little each month on the other. Today, she owns a home, has a credit score around 750, and is the CEO of Strategic Office Solutions -- a consulting firm that helps small businesses avoid financial disaster -- and Normal Moments, a nonprofit that assists families with critically ill children.

Keep a Card Handy

Doug Minor of Easy Credit Relief says that people eyeing bankruptcy can avoid destroying their credit by keeping at least one card or loan outside the bankruptcy case. "If someone has one card where there's little or no balance, it probably won't impact the case," he says, "but it could help that person start re-establishing credit after the bankruptcy is filed."

$300,000 in Debt

Glenn Phillips, president of a million-dollar database development company called Forte Online in Pelham, Alabama, has had a rocky road with his credit. At one point, he was nearly $300,000 in debt. "I started the business in 1991, and we were doing well by the late 90's," he says. "But the economy slowed down in 2001. We lost some business. And I got divorced in 2003. I had about $60,000 in credit card debt, $80,000 in a mortgage, and owed $150,000 from running my business poorly."

Phillips eliminated his business loans and credit-card debt by selling everything, including his house. He rented an apartment with a roommate and took on a business mentor to help him sort out his finances. "I spent hours going through what the company was making money on, where we were undercharging, and where we were losing money," he says. "We adjusted some of our fees and started creating a cash safety net."

Nothing Personal

Anyone starting a small businesses can avoid financial catastrophe by establishing a business credit card rather than mixing company and personal debt, Minor says. "Business credit cards usually don't report on your personal credit," he says, "so if the company goes down, your personal credit won't also."

A Bundle of Joy -- and Worry

Marc Kruskol, president of MJK Public Relations in Van Nuys, California, had his finances under control until the stork came for the fourth time. "Some people call her the miracle baby, because she came at a time when my then-wife wasn't supposed to be able to have kids," says Kruskol. "She had planned to go back to work, but with the baby, she couldn't. That's when things went awry."

Kruskol kept his spending in check, but his single salary couldn't support six people and a mortgage. Over the next decade, he racked up "thousands" in credit-card debt, and his credit score slipped to the 500s. The situation kept getting worse until Kruskol changed jobs, upgraded his salary, reduced his spending even further, and educated himself about credit scoring.

Lessons Learned

Six years later, Kruskol owns a business, and his credit score is over 700. "I didn't know you shouldn't keep your credit around 30 percent of your limit, or that getting too many cards could hurt a score," he says. "I started sending out letters asking creditors to validate my debts; slowly, my score increased over 200 points."

Along with self-education, using a certified financial or credit counselor can help consumers ferret out budget leaks and overspending, Williams says. "Almost everyone can benefit from having a third party evaluate your spending patterns and card usage," she says. "There's a misconception that if you see a credit counselor, it automatically goes on your credit report. It only goes on your report if you enter into a debt recovery program."

Christina Couch is a freelance writer based in Chicago and the author of Virginia Colleges 101: The Ultimate Guide for Students of All Ages.

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