As the last resort for people who have no other option, bankruptcy is a tough and costly road to go down. Since a bankruptcy can stay on credit reports for seven to 10 years, re-organizing your finances and rebuilding your life after filing can feel like a constant uphill battle for not just your finances but also your psychological health. It can feel like the financial equivalent of breaking a mirror: seven years (or more) of bad luck.
However, after making the difficult decision to file for bankruptcy, don’t let the mistakes of your past haunt you from having the life you want. Through a lot of hard work and responsible corrective behaviors, your credit score can recover in a few years and your financial house will be back in order before you know it. Here’s what you need to know about rebuilding credit after bankruptcy.
The Type of Bankruptcy Matters
First and foremost, it’s important to know how the two different kinds of bankruptcy impact your financial future:
Chapter 7 Bankruptcy
A Chapter 7 bankruptcy is known as a “liquidation” that wipes out all your debts. To file for a chapter 7 bankruptcy, you typically have to make more than the median income in the state you reside in.
Most of your assets are sold to pay off creditors, but you are able to keep some of your possessions, like your home, car, and clothing. You’re required to continue making payments on the possessions you keep.
At the end of this process, your debts are wiped clean, but the dark mark remains on your credit report for 10 years and presents more difficult and longer-reaching complications for your credit than a Chapter 13 bankruptcy does.
Chapter 13 Bankruptcy
A Chapter 13 bankruptcy is the most common type of bankruptcy, and involves a plan to pay off part or all of your debts over the course of three to five years. In this process, your legal counsel can help you come up with debt repayment plan that’s manageable for you and acceptable to your creditors.
While this type of bankruptcy stays on your credit report for seven years, successful repayments can slowly counter the negative hit. It’s still possible to move on with your life while you’re working to pay off your debts. For instance, you can still get an FHA home loan in the middle of a Chapter 13 bankruptcy.
It’s also important to know that bankruptcy does not get rid of all debts, so make sure you continue to make payments to child support, alimony, some student loans debt, some taxes, and even debts acquired six months prior to filing.
Rebuilding Your Credit After Bankruptcy
The first thing you need to remember is that the entire purpose of bankruptcy is to get your financial life back on track. So rather than thinking about bankruptcy as the end of the line, consider it a new beginning.
What’s more, remember that older information on your credit report is less important than more current data points. With this in mind, let’s talk about what you can do to start repairing your credit after bankruptcy.
Create a budget.
It is important to learn from your past mistakes so you don’t end up in the same position again. Work with a credit counselor to set up a budget, to help you create a spending plan, manage cash flow, and prevent you from racking up future unnecessary debts.
While it’s always been important, it’s even more critical now to stay on top of your finances by learning to live below your means to prevent new debt from spiraling. Consider setting up automatic payments, prioritize your expenses, and build a savings nest for life’s rainy days.
Plan a credit strategy.
After bankruptcy, it’s important to have a strategy in place for how you’ll repair your credit score. First, stay on top of the state of your credit by checking your free annual credit reports with all three credit bureaus, and dispute any errors immediately if you find them. Next, regularly check your credit score so you can track your progress and better understand how your financial activities impact your score.
Choose the right product to rebuild your credit (usually a secured credit card).
You may think no creditor or lender would be willing to work with you while you’re going through bankruptcy, but that’s far from the case. For instance, if you’ve managed to keep your house after bankruptcy and are making up-to-date mortgage payments on it, then you may be repairing your credit faster than you think.
As soon as you are able to, it’s time to consider getting a credit card. While you may be reluctant to do so at first after your past experience with debt, trust that you’ve learned from your mistakes. It’s also important to know that there is no way to start repairing your credit without using credit.
When looking for the right product to help you rebuild your credit, research the best credit cards for borrowers with bad credit. You want to look for a card that:
- Has low (or no) upfront fees.
- Offers prequalification checks.
- Reports to all three credit bureaus.
You may not qualify for a traditional credit card right away, but if you don’t, it’s important that you start with a secured credit card, not a prepaid debit card. The first will report your payments and credit activity to the credit bureaus to help you re-establish good credit; a prepaid card will not.
Most secured cards require a deposit, such as $500, which acts as your credit limit. Make small purchases each month, pay them off on time, and you’ll eventually get upgraded to an unsecured (traditional) credit card with lower interest rates. You’ll get your deposit back once you close the account or switch to an unsecured credit card.
If you’re having problems qualifying for a secured credit card, one option to consider is having a friend or family member add you as an authorized user on their card. This will only help build your credit if the card is used responsibly — and if the credit card issuer reports authorized users to the credit bureaus (most major issuers do, including Chase, Capital One, American Express, Bank of America, and Discover). Another option is to have someone cosign a credit card or loan for you, which can give you access to credit that can help you rebuild your score.
However, in either case, remember that your friend or family member is risking their credit reputation to help you. If you happen to fall back into your old, reckless ways, they’ll be on the hook for your debts — so you’re not just risking financial woes, but a personal relationship too.
Use your new credit carefully.
The important thing is to make sure you don’t get in over your head again. Use your credit for simple purchases, like gas and groceries. Budget for these purchases and pay the card off every month. That’s going to start establishing a good payment history — the single most important component of your credit score — as well as a favorable credit utilization ratio, or how much of your available credit you’re using.
Once you get your credit back on an upward trajectory, what else can you do other than making payments on time and keeping your credit utilization low? Check your free credit reports regularly: If there’s an error or a problem on your credit report, it’s even more important to make sure that you get it removed sooner rather than later.
Now, some specific loans and credit lines have built-in waiting periods after you declare bankruptcy. You can’t get a car loan, for example, until after your debts have been discharged. Your interest rate will also be very high — so paying for a car in cash is a better option. Conventional mortgages require a four-year wait after bankruptcy, but you can get an FHA loan after two years.
Other than that, it’s just a waiting game. But the more positive new activities you add to your credit report, the less your past damaging ones will matter. You may regret the behaviors that led you to file for bankruptcy, but if you do all the things you wish you’d done with your old credit life, your credit will soon start to right itself. It may take between seven and 10 years for the bankruptcy to drop off of your credit report entirely, but if you aggressively practice smart financial behaviors, you’ll soon have a future with lower rates, lower fees, and a healthy handle on your finances.
The Key to Rebuilding Credit After Bankruptcy
Summing up, the best way for most people to rebuild their credit after bankruptcy starts with a good secured credit card. Since the upfront cash deposit acts as your credit limit, you don’t risk falling into a new debt spiral, and banks are more likely to approve you since they have little to lose (you’re borrowing against your money, not theirs). Just make sure to choose a card with low fees (and no hidden charges), and then use it to make small, necessary purchases you can quickly pay off.