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Related topics: debt, credit, financial planning, retirement planning, Liz Weston

Two years ago, Jennifer Beach had a little piece of the American dream.

She lived with her husband and three children in a nice house in a good neighborhood in Florida. They had money in the bank, an affordable fixed-rate mortgage and a 401k.

"We thought we were doing everything right," Jennifer said.

Then her oldest daughter, then 13, got sick and spent a month in the hospital, followed by three months in a wheelchair

The girl recovered, but the family's health insurance didn't cover all the bills, which now total more than $80,000. Jennifer lost her job after taking too much time off to care for her daughter. A few months later, as the recession deepened, her husband lost his job.

Attempts to modify their mortgage turned into "a cruel joke," Jennifer said, as their lender repeatedly lost the paperwork they sent. Jennifer and her husband drained their savings trying to keep afloat.

Image: Liz Weston

Liz Weston

Today, Jennifer is divorced, unemployed, living in her parents' West Virginia home with her kids and wondering how she'll ever get back the life she once had -- or even manage to repair the credit devastated by all the unpaid bills.

"I don't have a car, I don't have credit cards, I don't have anything. It's like I fell off the map," she said. "How do you get back on your feet after something like that?"

Millions of Americans have seen their finances wrecked by unemployment, foreclosure, medical bills or other setbacks, and are likely wondering the same thing: How do you rebuild after financial disaster?

Here's the reality: You may never get back the life you lost. But it is possible to rebuild your finances and your credit over time.

This column won't help you if you're still in the middle of your crisis, although it may give you hope that there will be life afterward. If you're still struggling, please read "How not to pay your bills."

Jennifer's economic recovery is still a ways off. She's attending a local college to get a business degree, an education paid for by Pell Grants. She also qualifies for food stamps and Medicaid, two forms of aid she never thought she'd need but is grateful to have.

Once she finishes school and finds work, however, she can start to refurbish her financial life. So can you, once your crisis is past and you have a steady income again. Here's how.

1. Start with your overhead

To make sure you have enough money left over to rebuild, you'll want to keep an eagle eye on your "must have" expenses -- the shelter costs, food, utilities, insurance, child care and minimum loan payments that form your essential bills. After losing so much and living without for so long, it would be easy to rush into commitments that you can't really afford in your efforts to restore some normalcy to your life. Resist the temptation. Keep those "must haves" under 50% of your after-tax income. For more, read "The 50/30/20 budget fix."

Be particularly cautious about housing costs and car payments, because it's easy to overdose on those. Read "The real reason you're broke" before you commit.

2. Get $500 in the bank

You now understand the need for a fat emergency fund, but building it up enough to cover three to six months of expenses can take years and shouldn't be your top priority right now. A $100 cushion in your checking account and an additional $400 in savings will be enough to cover most minor emergencies. Plus, it will start you on the road out of paycheck-to-paycheck living.

3. Start contributing to your retirement accounts

You may be shocked to see this task so high in the priority list, but there's a reason: Retirement is expensive, and it's coming sooner than you think. Every day you delay costs your future self real money. Even if you don't get a company match, contributing to a retirement plan can help reduce your taxes and help you build the savings you'll need down the road. If you've been spooked by the market -- and who hasn't? -- you can start with low-risk options and ease into stock market investments over time. The point is to get started again.

4. Assess your debt

Few people take on debt without fully intending to pay it back. But sometimes, that's just not possible -- and continuing to struggle with impossible debt just delays any potential financial recovery. Or it could make matters worse. Creditors who may have left you alone while you were unemployed, for example, may well sue you once you have wages they can garnishee.

You should talk to a bankruptcy attorney if any of the following are true:

  • Your unsecured debts, such as credit card and medical bills, equal or exceed your annual income.
  • You're struggling to pay the minimums on your debt.
  • You've been sued by a creditor.

It's hard to imagine, for example, that Jennifer will land a job that pays enough for her to conquer those medical bills. Filing bankruptcy or negotiating settlements may be her only realistic options if she wants to avoid being sued once she's steadily employed.

Even if your situation isn't quite so dire, if you feel overwhelmed by your debts you might want to consult a bankruptcy attorney and a legitimate credit counselor (one affiliated with the National Foundation for Credit Counseling) so you understand your options.

If you think you can pay off your debts on your own, read "A debt payoff plan that works" for advice on how to go about it.

5. Rebuild your credit

You may feel burned by your creditors and convinced you'll never want credit again. But your credit scores will be vitally important if you ever want a mortgage or an auto loan. Credit information is also used by insurers, landlords and employers, so your credit history and scores aren't something you can ignore. The good news is that you don't have to take on onerous debt to fill your credit reports with positive information to help offset past setbacks.

The key to repairing your credit is having and responsibly using credit cards. If you don't have any plastic, consider getting a secured credit card, where you make a deposit with the issuing bank -- usually $200 to $1,000 -- and get a card with a limit in the same amount. If you use the card lightly but regularly, charging no more than 30% of its limit and paying it off in full every month, your credit scores should slowly improve.

Don't fall for credit-repair scams. There is nothing a credit repair company can do for you that you can't do for yourself, other than take your money.

Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.