Rebuild Credit after Bankruptcy
A Chapter 7 bankruptcy gives you the relief of a clean financial slate — but also the worry that you’ll never have decent credit again. You can rebuild credit after bankruptcy.
If you were eligible to file Chapter 7, chances are your credit was in tatters. But that’s different from the common misconception that bankruptcy ruins your financial future forever.
The truth is you can begin to rebuild your credit after bankruptcy right away.
Although a bankruptcy will remain on your credit reports for 10 years, its impact will fade with time. You can help the process by offsetting the negative information on your credit report with something more positive.
Start with the basics
At this point, lenders would like to see that you have enough income to pay your current obligations, and have a little left over. A lighter debt burden makes you a more attractive borrower.
Also, lenders won’t have to worry that you’ll file for bankruptcy to get rid of any new debt; you won’t be able to receive another discharge of your debts for eight years.
Here’s your first order of business: Create a budget to help you stay on top of your finances. The pre-discharge credit counseling you went through before finishing your bankruptcy should have provided information on budgeting, but if not, don’t hesitate to seek help from a credit counseling agency. All nonprofit credit counseling agencies offer free basic consumer help on topics such as budgeting.
Next, begin building an emergency fund. Research by the Urban Institute shows that having as little as $250 in savings for an unexpected expense can protect families from resorting to payday loans or running up credit cards, which can start a new debt spiral.
Plan your post-bankruptcy credit strategy
You might think you’re a pariah in the eyes of lenders and credit card issuers, but that’s not quite true. You’ll have to prove yourself, of course, but it can be done.
Although your goal — building a good credit score — is the same as that of someone starting from scratch, your situation is a little different. Your problem isn’t that creditors don’t know anything about you, but rather that they know a lot.
First, assess your situation. You can do that by checking your free annual credit reports. These can look daunting, but our guide to reading them can help you decipher what the entries mean. Your credit scores are calculated using information in your credit reports, so any inaccurate negative information can make it even harder for you to dig out of debt. If you find errors, dispute them and get them corrected.
Of course, there will be negative information that is accurate. Your reports will show your bankruptcy for 10 years. Also, late payments and debts that go to collection remain on the reports until seven years after the delinquencies. A Chapter 7 filing wipes out debts, but it doesn’t wipe your credit reports clean.
Second, check your credit score. There are several sources of free VantageScores, and Discover offers free FICO scores even if you are not a cardholder. It’s smart to track your credit score month to month, and it’s crucial to look at the same score each time — otherwise, you’ll get a not-useful apples-to-oranges comparison. Pick one type of score to track and stick with it.
Cleaning up your credit reports and knowing which credit score will be seen by lenders helps you know which credit products to apply for.
Seek a product that suits your situation
Your pre-bankruptcy payment history will make you look like an extremely risky borrower to lenders. You can fix that problem by providing extra assurances that they won’t lose money by lending to you. Here are four ways to improve your financial respectability and get credit to help rebuild your score:
Secured loan: This comes in two varieties, and most often is offered by credit unions or community banks. One kind of secured loan involves borrowing against money you already have on deposit. You won’t be able to access that money while you’re paying off your loan. The other kind can be made without cash up front, though the money loaned to you is placed in a savings account and released to you only after you have made the necessary payments. In return, the financial institution agrees to send a report about your payment history to the credit bureaus.
Secured credit card: This kind of card is backed by a deposit you pay, and the credit limit typically is the amount you have on deposit. A secured card often has annual fees and may carry high interest rates, but you shouldn’t need it for the long term. It can be used to mend your credit until you become eligible for a better, unsecured card.
Be aware that you can be rejected for a secured card. Read the requirements carefully; you’ll want to be almost certain you can get approved before you apply for one, because each credit inquiry can cause a small, temporary drop in your score. This decline will be more than offset if you get a card, use it lightly, and pay the debt on time.
NerdWallet credit card expert Sean McQuay recommends applying for a secured card at a credit union or other local bank. “They tend to be much more lenient with credit history, and many will be happy to work with you to build your credit profile,” he said. “One big caveat, however: Before applying, make sure the bank or credit union reports credit activity to all three credit bureaus. Make sure your good credit behavior counts.”
Co-signed credit card or loan: This can help your score, but you need to have a friend or family member with good credit history who is willing to co-sign for you. It’s a big ask: A co-signer is risking his or her credit reputation for you, will be on the hook for the full amount if you don’t pay, and may face limits on personal borrowing because of the additional debt obligation. A co-signed card or loan can damage relationships if you don’t pay as agreed.
Authorized user status: If asking someone to co-sign is too much, you could instead ask to be an authorized user on that person’s credit card. But make sure the credit card will report payment activity by authorized users to the credit bureaus, or it won’t help build your score.
This route won’t boost a score by nearly as much as the other methods, because authorized users don’t have ultimate responsibility for repaying debt. (It is much more likely to help someone who has a “thin file” with little credit information in it than someone who has a file chock-full of negative information.) But this path won’t hurt, so you may want to pursue it.
Once you get a lender to extend credit, be vigilant about paying on time. Keep your credit card balances low relative to card limits — less than 30% is typically advised, but less than 10% is even better.
You’re already seeking redemption, so you can’t put yourself in a position where you’re begging for forgiveness for a late payment or struggling to keep up with mounting credit balances.
When your recent history finally shows you are a good credit risk, your vigilance in restoring your credit reputation will pay off.
This information was obtained from NerdWallet and Bev O’Shea, a staff writer at NerdWallet