Rebuilding Credit After Bankruptcy: It IS Possible!

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Filing bankruptcy can provide the relief you need right now by protecting you from your creditors and eliminating most or all your debts. But, many people worry about the effect bankruptcy will have on their credit reports and FICO scores. While bankruptcy is a negative notation on everyone’s credit report, many people overestimate the impact a bankruptcy filing will have on their credit. Many also underestimate their own ability to rebuild their credit, while overestimating the effect that showing a bankruptcy filing on your credit report can have in the long term. Understanding the path to rebuilding your credit is the first step to creating and maintaining a positive credit history. 

Most people considering bankruptcy have already fallen behind on their bills and may already have accounts in collections. That means many already have low credit scores when they file for bankruptcy. Whether you file a Chapter 7 bankruptcy or Chapter 13 bankruptcy, as long as you are motivated but thoughtful in your credit repair efforts, your credit score will almost certainly be better a year after your bankruptcy discharge compared to when you first filed. 

So, How Can I Rebuild My Credit After Chapter 7 Bankruptcy?

Everyone’s path to better credit is a little different, depending on their income, expenses, credit needs, and other factors. The information in this article will give you a solid foundation for steps you can take to rebuild your credit and maintain a healthy credit report in the future. While everyone’s financial situation is different, the steps below are building blocks that nearly anyone can use for rebuilding credit post-bankruptcy. 

Create a Budget

One important step toward rebuilding credit is making sure that you don’t fall behind on bills again. Any late or missed payments after your bankruptcy filing will send your credit score in the wrong direction and put a new black mark on your credit history. Creating and sticking to a budget is something everyone should do no matter what, but it’s especially important after a bankruptcy filing.

Creating a budget you can stick to requires some work. You can’t just estimate your income and expenses. Use the information from your bankruptcy forms as a starting point. Then, you’ll want to track your expenses for a month or two, making sure that you include everything you spend money on. Compare those expenses with your income, paying special attention to how often you are paid. If your expenses are greater than your income, or there’s no room left in the budget to save money for emergencies and long-term goals, something has to change. You’ll either want to find a way to increase your income or cut out some expenses--or both.

One way to budget is to start with your most important items, such as your rent, utilities, and monthly medical bills for items like prescription medicine that you have to refill on a regular basis, then work down the list. That way, you make sure the most important expenses are covered before you consider categories such as travel and entertainment.

If this sounds complicated or confusing, don’t worry. You’ll get more detailed information about budgeting and cutting expenses in the financial management course you complete before receiving your bankruptcy discharge. And, there are many free or inexpensive tools and apps that can make this easier. 

Build a Rainy Day Fund and an Emergency Fund

An unexpected expense can break your budget and trigger late payments that undo some of the hard work you’ve done toward rebuilding credit after bankruptcy. A savings account can provide the buffer you need to keep moving in the right direction when you need a car repair, your daughter needs a cavity filled, or the furnace breaks down in the middle of winter. 

The extra cash or savings you keep on hand for this type of expense is often called a “rainy day fund,” because it’s designed to fill the gap when something beyond your control disrupts your budget. Having a rainy day fund also provides a better alternative to using high-interest credit cards or credit line to cover emergency expenses.  

Your emergency fund will be larger and take longer to build. The rainy day fund is intended to cover one-off expenses that are outside your usual budget. The emergency fund provides a safety net for events that significantly disrupt your life. Some examples include serious illness that interrupts your ability to work, divorce, and job loss. Ideally, this emergency savings account will contain enough money to cover six months of living expenses.

Get a secured credit card

Those who avoid using credit or even getting personal loans after bankruptcy cheat themselves of the opportunity to build a strong track record. That’s often a mistake, because payment history is one of the key factors the Fair Isaac Corporation uses in determining FICO scores.

Still, opening new credit accounts with a reasonable interest rate and a manageable annual fee may be difficult immediately after bankruptcy. And, some people who had difficulty managing credit in the past understandably feel it would be risky to start using credit cards again. A secured credit card may offer a safer and more accessible alternative. 

A secured credit card, sometimes called a prepaid card, is easier to get than an unsecured card, because a cash deposit is required to protect the creditor. For example, you might be approved for a $500 credit limit, but be required to send the credit card company $500 to hold as security. When you choose the right secured card, billing, interest, and credit reporting work like any other credit card. You’ll have a monthly minimum payment due, and your on-time payments will be reported to the three major credit bureaus.

As long as you make your payments on time and keep your balances low, your secured credit card can have a positive impact on your credit report and help improve your credit score.

Get a secured credit builder loan

Sometimes, rebuilding credit after bankruptcy requires more than just the responsible handling of your day-to-day finances. Like a secured credit card, a credit builder loan is primarily a tool to help you rebuild credit after bankruptcy or some other negative credit event. The way a credit builder loan, or “fresh start loan,” typically works is that the lender deposits the funds you have “borrowed” into a savings account. Though the account is in your name, you generally won’t be able to withdraw funds right away. Instead, the bank or credit union will keep the funds as security while you make payments. 

Assuming that you make your payments on time, this will help you establish a positive payment history and help build credit. When you’ve repaid the loan in full, the funds in the security account will be released to you.

Not every bank offers credit builder loans, so you may have to shop around for a community bank or credit union that offers this option, or look for a reputable online lender. Make sure the lender you choose reports to the three major credit reporting agencies: Equifax, Experian, and TransUnion. And, compare interest rates. Though the loan is a tool for rebuilding credit, the interest you’ll pay is very real, and you’ll want to keep costs low.

Get a Co-Signed Card or Loan

For a person with bad credit, a co-signed loan offers many advantages. A family member or friend with established credit can help you secure a personal loan when you might otherwise not qualify. Having a co-signer with good credit can also lower interest rates and allow you to avoid the requirement of making a higher than usual security deposit (in the case of a rental agreement, for example), since the risk to the lender is lower. 

However, co-signing a loan is risky, and not something you should ask someone to do lightly. If you make payments late, those late payments will show up on your co-signer’s credit history, and affect their good standing with the creditor. If you stop paying on the loan, your co-signer can be sued for the full balance, plus interest, fees, and collection costs. Even if your payments are on time, co-signing a large or long-term loan can affect your co-signer’s access to credit while the account is open. 

So, while co-signing can be a good option for people attempting to purchase a car or borrow money while rebuilding credit after bankruptcy, it’s important to think through all of the potential problems that come with it. Be sure that you can repay the loan on time, and carefully consider who you ask to co-sign for you.

Authorized User

People thinking about how to build credit after bankruptcy often ask about becoming an authorized user on someone else’s credit card account. At one time, becoming an authorized user was a popular means of building credit. But, building credit this way requires some research and planning. And, the arrangement carries some risk for both people.

Being listed as an authorized user on someone else’s card can help your credit because the account will often be listed on your credit report, even though you aren’t responsible for the payments. But, not all credit card issuers report on authorized users. So, if you’re considering this type of arrangement to build your credit, have the person who will be authorizing you check with their credit card company to make sure they will report the account on your credit history.

You should also be aware that in some situations, the account could negatively affect your credit. For example, if the account holder makes a payment late, that late payment will be reflected on your credit report, even though it wasn’t your responsibility in the first place. And, if the balance on the credit card is high, you could take a hit for high credit usage. 

Monitor Your Credit

Of course, rebuilding credit after bankruptcy requires keeping a close eye on your credit report in addition to keeping an eye on your personal finances. It’s the only way to track progress and ensure your credit repair efforts are making a difference. You’ll want to review your credit reports from all three major credit bureaus and get your credit scores when you start rebuilding. This is important as a baseline, but also because there may be errors on your credit report that need to be corrected.

TransUnion, Experian, and Equifax are all required to give you one free credit report each year. You can get these directly from the credit bureaus or request them all from the online through the official site to get your free annual credit reports. Your free credit report won’t include your credit score, though. You can purchase your credit score from the credit bureaus, but it’s usually not necessary. Many credit card companies and banks now also provide free credit scores to their customers. So, spending money on a credit check can be avoided completely if you plan ahead. 

Many people filing for Chapter 7 bankruptcy have credit scores in the mid-500s. Most lenders consider scores in the 620-640 range acceptable. A score of 720 or above is generally considered good, and will qualify you for most types of credit and for better terms.

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Keep Monitoring Your Credit

Don’t just think in terms of how to build credit after bankruptcy. While rebuilding credit after bankruptcy is a short or medium-term project, maintaining good credit is a long-term commitment. Tools like secured credit cards, working with a co-signer, and credit builder loans can help you turn bad credit around. But, building good credit in the long-term requires a commitment to better budgeting, careful management of credit accounts, keeping credit card balances low compared to your available credit, and making informed financial decisions. 

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Conclusion

Think of rebuilding credit after any type of bankruptcy as the first step in a journey toward a healthier, more stable financial future. But, make sure to use your credit card or line of credit with the primary goal of rebuilding your credit in mind. It doesn’t make sense to get a number of credit cards with high interest rates and high annual fees, as it is way too easy to have unsecured credit card debt snowball out of control that way. To that end, make sure you set up a checking account with a debit card (if you don't have one already) and use that as your primary method of paying for living expenses. Make regular monthly payments on your car loan(s) and student loans using your debit card and keep your credit card strictly for the purpose of rebuilding your credit. Stay engaged, informed, and on top of your budget so you can adjust as necessary and appropriate. Before you know it, your new budgeting tools will become a habit that not only helps you build, but also maintain great credit.

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Upsolve is a 501(c)(3) legal aid nonprofit that started in 2016. Our mission is to help low-income Americans in financial distress get a fresh start through Chapter 7 bankruptcy at no cost. We do this by combining the power of technology with attorneys. Spun out of Harvard Law School, our team includes lawyers, engineers, and judges. We have mission-driven funders that include the U.S. government, former Google CEO Eric Schmidt, and private charities.

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