Our cultural DNA demands we never give up on repaying our debt.
So filing for bankruptcy — asking someone else for help with our debt — can feel like the end of a long road of personal finance failures.
But there’s another way to look at bankruptcy: as a fresh start, as the first step on a new road to financial independence.
If you’ve reached a junction in your financial life and you’re considering bankruptcy, be sure to plan ahead so you can start rebuilding your credit after bankruptcy.
Rebuilding Credit After Bankruptcy
Sure, you’ll be relieved to be out of debt when your bankruptcy process is complete, but you’ll have to deal with a new challenge: credit repair.
Chapter 7 Bankruptcy will be part of your credit history for 10 years; Chapter 13 Bankruptcy stays on your credit report for seven years.
Lenders will see the bankruptcy in your credit profile and immediately decline your application for car loans, mortgage loans, and personal loans.
Your financial life will be harder: With bad credit, you’d need to pay cash upfront for large purchases. Public utilities would require an upfront security deposit; you’d probably need a pre-paid cellphone plan.
You could get some credit if a family member agrees to serve as a co-signer. Even then, some lenders don’t allow co-signers.
Steps To Rebuild Credit After Bankruptcy
With a bankruptcy filing in your credit history, lenders won’t trust you.
So can you do anything to help your personal finances after bankruptcy? Do you just have to wait for the bankruptcy filing to age off your credit report?
Yes, you can start rebuilding good credit even within the shadow of a bankruptcy discharge.
You likely won’t see immediate results in your credit score, but you’ll still be paving the road to a brighter future by taking these steps.
When the bankruptcy does age off, you’ll be set up for success.
Step 1: Check Your Credit Report for Accuracy
First things first: Make sure the old debts on your credit report are built into your bankruptcy discharge and not listed as current debt.
If the old debt continues to be listed as current, it’ll keep haunting you, extending your period of bad credit and undermining the fresh start your bankruptcy should provide.
Wait 30 days after your bankruptcy discharge and then get a free credit report from each of the three credit bureaus, Experian, Equifax, and TransUnion.
You can get a free copy of each bureau’s report from annualcreditreport.com. (Typically you’d get one free copy a year but through April of 2021 you can get a free credit report each week.)
If you see old, discharged debt listed as current debt, start sending dispute letters right away. You shouldn’t have any problem getting this inaccurate information removed.
As you know, your bankruptcy won’t discharge all your debt. Student loan accounts, for example, will remain active. Be sure to keep these accounts up to date by making timely payments.
Step 2: Create a Sustainable Budget
In Step 1 you confirmed your bankruptcy filing is doing its job by hitting the reset button on your old debt. Next, it’s time to focus on building a sustainable personal finance life so you’ll be all set once your credit report is free of bankruptcy filings.
Yes, unexpected problems will arise to wreck our best financial plans, but that’s actually a good reason to develop better budgeting habits. That way you’ll be better prepared when the unexpected happens again.
So make a realistic budget — one you can actually live by. Leave some room for real life expenses like eating out once in a while. Budgeting works best when you follow your spending plan week after week and month after month.
You should start a savings account and set up automatic deposits every time you get paid. High yield savings accounts pay higher interest rates than the savings accounts at local bank and credit union branches.
Try to save up enough money to pay for three months worth of living expenses.
Having less access to available credit — especially credit card accounts — can work in your favor during this rebuilding phase of your financial life.
Step 3: Apply for Special Types of Credit
Once you’re comfortable with your budget and prove to yourself you can live within a spending plan, it is time to start rebuilding your credit life again.
You can’t improve your credit score without having active credit accounts. But you can’t open credit accounts without a serviceable credit score.
So how do you solve this Catch-22? Should you wait until the bankruptcy filing ages off your credit report?
You don’t have to. You can find special credit accounts to jump-start the process:
- Secured Credit Cards: A special credit card account that you back yourself.
- Credit builder loans: A special kind of loan that you use only to build your credit.
- Loans with a co-signer: A family member or friend can back you up so you can open a new line of credit or credit card account.
- Becoming an authorized user: You can use someone else’s credit account to improve your repayment history a little.
Here’s some more information about these special accounts:
SECURED CREDIT CARDS
When you get a secured credit card, you’re the lender and the borrower. You have to deposit a lump sum, such as $500, into the credit card account. Then you can use the card as you would an unsecured card.
You’ll have a low credit limit, high fees, and no borrowing power. But you’ll also get a chance to make on-time payments to a credit card company on a regular basis. Payment history is a huge chunk — about 35 percent — of your FICO score.
You’ll have to pay an annual fee, but it’ll be worth it when the credit reporting agencies see your good financial decisions.
I suggest setting up automatic payments so you don’t forget to make the monthly payment. MIssing payments would undermine the entire point of a secured credit card.
CREDIT BUILDER LOANS
A lot of banks and credit unions offer credit builder loans. You “borrow” an amount that goes directly into a savings account.
You never access the money, but you’ll be making timely payments. In fact, the bank will set up automatic payments so you’ll never make a late payment. The payments will come from the savings account.
Over time this kind of loan can build up your credit history because the credit reporting agencies will see your consistent monthly payments.
LOANS OR CREDIT CARDS WITH A CO-SIGNER
You can build a more stable credit history by asking a family member to co-sign on a car loan or a credit card account. Your credit report will reflect this new credit account which can help your score.
The family member or friend who co-signs will be taking a chance on you. He or she would be responsible for your credit card balances if you defaulted.
So be sure to make regular, on-time payments on this new credit card or loan. Better yet: Pay off the balance every month.
The major credit bureaus will see your improving repayment history and low credit utilization ratio, and you’ll be further along the road to good credit.
BECOMING AN AUTHORIZED USER ON SOMEONE’S ACCOUNT
As an authorized user on someone else’s credit card account, you could possibly help your credit score a little — but not as much as you could with an account of your own.
Not all creditors report the activity of authorized users of accounts. So don’t count on this strategy by itself.
Monitoring Your Credit Score after Bankruptcy
It’s easy enough to forget about your credit score after a bankruptcy, but it’s essential to monitor your credit score during this time.
These apps will show you credit card offers, that’s how they make money. But you don’t have to respond to them; in fact, you likely wouldn’t be approved for a new credit account anyway if you’ve just filed bankruptcy.
These apps won’t show your official FICO score, but you can use them to see trends. If your credit score drops significantly, get a copy of your free credit report at annualcreditreport.com to see what’s going on.
Credit Report Basics: How to Build a Better Score
Sooner or later your Chapter 7 or Chapter 13 Bankruptcy will be a distant memory.
When that happens, your credit score will bounce back, especially if you’ve laid a solid foundation in the years after filing bankruptcy.
To achieve a good or excellent credit score, pay attention to:
- Payment History: Using your secured credit card or credit-builder loan to establish a consistent repayment history is the single most important thing you can do to breathe new life into your credit score.
- Credit Utilization Ratio: Keeping your credit balances paid off — or at least paid down to 30 percent of your available credit — will help your credit score recover more quickly. It’s OK if it takes you a while to open enough accounts to achieve a good credit utilization ratio.
- Length of Credit History: The fresh start bankruptcy offers means the average age of your credit accounts will be shorter than before. But starting some new accounts now will help you have a longer credit history when your bankruptcy ages off.
- Mix of Credit Accounts: Once again, your bankruptcy will mess with your mix of credit accounts, but by opening a secured credit card and a credit builder loan, you’ll be on your way to a better variety of credit accounts.
- New Credit Checks: Unless you know you’ll be approved for a loan or credit card account, don’t apply. Too many hard credit checks in a year can hold you back.
Bankruptcy Could Be the Opportunity You Need
Nobody wants to go through a bankruptcy process. You’ll have to hire an attorney, pay fees, and endure seven to 10 years of having the filing on your credit history.
But if you have no other choice — if there’s no way you can get your debts under control and still provide your basic needs — you should see bankruptcy as an opportunity for a fresh start.
Take advantage of your fresh start by developing better habits and putting together the elements of a good credit score over the next few years.
When you come out from under the cloud of bankruptcy, you’ll not only get approved for new credit but you can get loans with the best interest rates and lowest fees.