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Rebuilding Credit After Bankruptcy
Bankruptcy can seem devastating, but it may be the fastest path to improving your credit score.
“Most people contemplating bankruptcy already have a low credit score, due to late payments, collections, et cetera,” says Jen Lee, managing attorney at Jen Lee Law, Inc. “Filing for bankruptcy is the first step in the rebuilding process. In fact, your score may even go up immediately after filing.”
Despite what many think, it is possible to reap the rewards of having a good credit rating, even with a bankruptcy in your past. If you’ve recently filed bankruptcy, and are ready to rebuild your credit and get back on track, here are the seven steps you need to know.
1. Address the root cause of your bankruptcy
There are underlying issues that lead to every bankruptcy filing. Before you begin the rebuilding process, it’s important to honestly reflect on the decisions and events that led you to that point. Don’t be too hard on yourself, but understand them and strategize how you will approach your finances differently going forward.
2. Make a budget
Next, make a budget that breaks down all of your income and expenses. Get crystal clear on your financial situation so you know where all of your money is going. Many mobile apps — like Mint, a crowd favorite — can help you in this process. Decide how much you can save each month and commit to it. Furthermore, analyze your spending on an ongoing basis to see if there are any areas where you can further save money. Budgeting is empowering because instead of handling bills and expenses as they come, you can get the bird’s eye view and tell your money what to do.
3. Save up an emergency fund
We can plan for all of our known expenses, but life is sure to throw curve balls from time to time. Whether your car breaks down or a pipe bursts in your house, you don’t want a surprise expense to put you back on the path to financial ruin. A recent survey found that only 40% of Americans are able to cover an unexpected $1,000 expense with their savings. The rest said they would have to take out a loan, use a credit card, borrow from a friend or didn’t know what they would do. To protect yourself and your budget, make it a priority to save up an emergency fund of at least $1,000.
4. Monitor your credit reports
Next, it’s important to make sure that your credit report is accurately reflecting the bankruptcy, meaning that all accounts included in the bankruptcy are showing a $0 balance. You are entitled to one free copy of each of your credit reports through Annualcreditreport.com every year. Additionally, some credit card providers, like Capital One, monitor your credit for you on an ongoing basis. Throughout your credit rebuilding journey, check in on your credit score regularly to ensure that everything is accurate and on track.
5. Establish new credit lines
“After filing for bankruptcy, it’s important to establish new lines of credit,” Lee advises.
How are banks going to trust you with new credit when you just filed for bankruptcy? The good news is there are several avenues for people with low-or-no credit. In fact, you may actually be surprised by the number of credit card offers you receive after your proceeding finishes.
The most accessible entry-level credit products are secured credit cards that require you to deposit around $100 to $500 upfront to gain access to the credit line. This protects the lender against the risk of you defaulting.
Once you get a card, you need to use it in a way that demonstrates control and responsibility. Don’t carry a balance that exceeds 30% of your credit line, as credit utilization makes up 30% of your credit score. Additionally, pay your monthly payments on time or early. Many card providers reward users who make timely payments and keep their credit utilization down by offering them unsecured credit line increases and/or refunds of security deposits.
For example, the Secured Mastercard® from Capital One offers cardholders to be automatically considered for a higher credit line in as little as 6 months with no additional deposit needed.
Other ways to establish new credit include having a co-signer help you get approved for a credit card or loan, or becoming an authorized user on somebody else’s credit card to reap the benefits of their timely payments. However, keep in mind that every time you apply for credit, the lender pulls your credit report. This triggers a hard inquiry which stays on your credit file for up to two years, so you don’t want to over-apply. Find a good offer, apply, then work on establishing that line of credit for six months to a year before applying again.
6. Make timely payments
Next, making timely payments across the board is key. The factors that make up your credit score are all weighted differently and on-time payments are the most important, accounting for 35% of your score. This is especially important if you have a co-signer on your loan or credit card as any misstep will also reflect on their credit.
But which payments are reported to the credit bureaus? In most cases, it is only credit-based accounts such as credit cards, mortgages, auto loans and personal loans. Paying for your rent, electricity, cell phone and other household bills generally does not directly impact your credit score. However, if you don’t pay those bills and they get sent to collections, that will cause a negative mark on your credit reports which hurts your score. That being the case, it’s best to plan to stay on top of all of your monthly bills.
7. Be patient
You didn’t get to the point of filing for bankruptcy overnight and you won’t get out of it overnight either.
“Time since the bankruptcy along with paying all your payments on time are keys to improving your credit score,” says Mike Brown, president of BlueLine Consulting Services.
A Chapter 7 bankruptcy can take 10 years to fall off a credit report, at which point your score could go up as much as 100 points. In the meantime, it’s important to be patient — and practice good financial habits.
The bottom line
Filing for bankruptcy does not mean the end of your financial credibility or ability to access credit products. By following these seven steps and committing to making better financial decisions, you can rebuild your credit score and begin to see positive results in as little as one year.