How to get out of debt with bad credit in 3 steps

When you have bad credit and a growing mountain of debt, it can feel like there’s no way out. However, there are a few steps that can put you on the path to being debt-free. While it can be difficult to turn the situation around, it’s possible. Here’s a closer look at what bad credit is, the various debt payoff strategies you can try, and tips on improving your credit score.

What is bad credit?

Bad credit generally refers to a credit score of 579 or less. About 61% of people whose scores fall in that range are likely to default on a credit account, according to FICO data. Due to this higher risk level, many lenders won’t approve bad-credit borrowers, or only offer them small loan amounts with high costs.

But how do you end up with bad credit? FICO scores are based on five main factors: payment history, amounts owed, length of credit history, credit mix, and new credit. Here’s a look at how each factor is weighted and the behaviors that cause your credit score to drop in each category:

• Payment history (35%): Missed payments, late payments, and credit account defaults.
• Amounts owed (30%): High credit utilization on revolving credit accounts and new term loans with large outstanding balances.
• Length of credit history (15%): The average age of your accounts is low.
• Credit mix (10%): Only having one type of credit account, such as revolving or installment.
• New credit (10%): Applying for or opening several new credit accounts in a short amount of time.

How to get out of debt in 3 steps

While a debt consolidation loan can help you get out of debt, it works best when it’s part of a larger strategy. Not sure where to start? Here are the three main steps to follow.

1. Make a basic budget

First, you need a clear understanding of your income, recurring expenses, and debts. Start by reviewing your finances from the past three months. Take note of your total income, total expenses, and remaining income each month. Then, find the averages.

For example:

January:

• Income: $5,000
• Recurring expenses: $4,750
• Remaining income: $250

February:

• Income: $5,200
• Recurring expenses: $4,750
• Remaining income: $450

March:

• Income: $5,500
• Recurring expenses: $4,800
• Remaining income: $700

Averages:

• Income: $5,233
• Recurring expenses: $4,766
• Remaining income: $466

From there, make two lists, one for your monthly recurring expenses, and one for your debts. When making the debt list, be sure to note the outstanding balance, monthly payment amount, and interest rate for each credit account.

For example:

2. Reduce expenses

Once you have a clear understanding of your financial picture, look for ways to cut down your monthly expenses. For example, can you switch to a cheaper phone plan, cancel media subscriptions, or plan cheaper meals?

Next, review your debts to see if you can reorganize them to save money. For example, suppose you have the debts in the table above and qualify for a three-year, $4,000 debt consolidation loan with an 18.00% APR and $145 monthly payment. If you use the loan to pay off the three credit cards, you’d have the same monthly payment but would cut your interest costs in half.

3. Create a debt payoff plan

After optimizing your expenses and debts, recalculate the total amount of money you’ll have left over each month. Then decide how much of that you want to put toward paying off your debts. 

For example, if you have $500 left over each month, you may want to save $200 for incidental spending and put an extra $300 toward paying off a debt consolidation loan. Once the debt consolidation loan is paid off, you could begin putting the extra $300 toward your car loan.

Make a plan for how much you’ll pay toward each of your debts, how long it’ll take to pay them off, and in what order you’ll pay them off (it’s often a good idea to pay off your highest-interest loans first). You can use our loan calculator to estimate the amount you can save by paying off an installment loan early.

Debt consolidation loans for bad credit

If you have bad credit and are paying off multiple credit accounts, a debt consolidation loan may be able to help. It involves borrowing a lump-sum installment loan and using it to pay off high-interest balances.

Along with reducing the number of payments you need to make each month, debt consolidation loans can lower your interest rate and give you a fixed repayment schedule with a payoff date — something revolving accounts lack. Additionally, they can reduce your overall borrowing costs and improve your credit by decreasing your credit utilization, as well as if you’re able to make timely payments.

Not all debt consolidation lenders will approve borrowers who have bad credit, but here are a few known for having flexible eligibility requirements.

Debt relief for bad credit

Want assistance in paying off your debts? Here are some places you can turn.

Credit counseling and debt management plans

If you’d like help making a debt payoff plan, consider a credit counseling organization that offers debt management plans. The organization will contact your creditors on your behalf to work out payment schedules and may try to negotiate down your rates. Then, they put together a debt management plan based on the agreements. Once the plan is set and everyone has agreed to it, you’ll deposit money each month with the credit counselor, and they’ll use it to pay your creditors. The plan and payments will continue until the debts are paid off.

Debt settlement and negotiation with creditors

Debt settlement companies are organizations that work to reduce the amount debtors have to pay their creditors to settle debts. In many cases, they ask you to stop making payments on your credit accounts and start paying into an account with them. The goal is to accumulate a lump sum amount that can be used to negotiate a settlement with your creditors and save you money.

But going this route can be risky. When you stop making your credit payments, it will likely damage your credit and can result in the accumulation of fees and penalties. It also can trigger aggressive collection attempts from your creditors and even lawsuits. While debt settlement companies may be able to settle your debts cheaper and faster than you otherwise could, there are no guarantees, and a great deal of damage can be done along the way.

How to improve your credit score

Paying off your debt is a good way to start to improve your score. Here’s what else you should do:

• Make on-time payments: Payment history is the most important factor in your credit score, so make all of your payments on time.
• Keep your credit line balances low: When you carry balances on revolving accounts, they increase your credit utilization ratio, which causes your credit score to drop. For the best score and to minimize interest costs, pay off your credit card balances each month before the end of the billing cycle.
• Keep revolving accounts open: The longer your credit accounts are open, the better. If you no longer plan to use credit cards, put the cards somewhere safe but leave the accounts open.
• Open more than one type of account: Ensure you have both revolving and installment credit accounts open for a good credit mix.
• Don’t overdo new credit: Limit hard credit inquiries. Look for lenders and companies that prequalify borrowers using a soft credit check. Don’t open multiple new credit accounts in a short period.
• Keep tabs on your credit reports: Check your credit reports periodically to ensure all of the information is accurate and up to date.

Along with the above steps, you may be able to quickly improve your score using Experian’s Boost program. To do so, create a free account with Experian, connect your bank account, and add bills like your rent, insurance, cellphone, and utilities. Experian will tell you right away if your FICO score can be boosted.

Methodology

We evaluated the best personal loan lenders for bad credit based on factors such as customer experience, minimum fixed rate, maximum loan amount, minimum credit score and income requirements, funding time, loan terms, fees, discounts, and whether cosigners are accepted. Our team of experts gathered information from each lender’s website, customer service department, directly from our partners, and via email support. Each data point was verified by a third party to make sure it was accurate and up to date.

FAQ

Can I get a debt consolidation loan with bad credit?

You may be able to get a debt consolidation loan with bad credit. Every lender is different, and some cater to borrowers with scores in the poor and fair categories. Find out if you prequalify by requesting quotes from multiple personal loan lenders before applying.

Is it better to pay off debt or save?

Due to the costs, it typically makes sense to pay off high-interest debt like credit cards first. That said, if you don’t have any savings and run into an emergency, you may be forced to accumulate more high-interest debt. So if you don’t have an emergency fund of at least three months' worth of expenses, you may want to establish that first. You’ll have to weigh the benefits and risks for your situation.

How to pay off debt in collections

If you have a debt in collections and want to pay it off, contact the debt collection agency. In many cases, you can make the payment online, over the phone, or by mailing a check. If you can’t pay the total amount or want to try and negotiate it down, give the company a call. They may be willing to settle for a lower lump-sum amount or set up a payment plan.