Because bankruptcy gives you the opportunity for a fresh start, it’s only the beginning of your financial journey, not the end. If your credit history is preventing you from getting a credit card, take advantage of secured credit cards as a way to rebuild your credit after bankruptcy.
Written by Attorney Alexander Hernandez.
Updated October 20, 2020
When you file for bankruptcy, you’ll be required to fill out forms in which you must list all of your assets and liabilities. Most of your unsecured debt will be eliminated during a successful bankruptcy and you may be able to keep your secured assets post-bankruptcy, including secured credit cards. Continue reading to learn more about how secured credit cards work and how maintaining secured credit cards could help improve your credit score after filing for bankruptcy.
What is Secured Credit Card Debt?
Debt is either secured or unsecured. Common types of secured debt include mortgages, auto loans, and other collateral-based lines of credit. Common types of unsecured debts include credit cards, medical bills, and student loans. Most types of unsecured debt are dischargeable in bankruptcy, but secured debt is not generally dischargeable if you’re keeping the asset.
Secured credit cards work just like unsecured credit cards do. However, instead of having the debt secured to a house or car, the debt is secured to a deposit. For example, if you deposited $500 with the lender, your credit line is now $500. As you make purchases with your secured credit card, the available credit limit will decrease just like a regular credit card’s limit would. Secured credit cards are typically used by people with poor credit who are looking to improve their credit over time. Secured credit cards are also known as prepaid cards. Getting a secured credit card is a lot easier than securing an unsecured card because secured card issuers bear little risk in approving you for a deposit-based card. If you fail to make your monthly payment, the lender will use your deposit towards the amount due.
There are several advantages to having a secured credit card. For one, secured lenders don’t require a large deposit to open an account, and checking your credit report or credit history isn’t necessary to open this kind of card. Also, just like an unsecured credit card, the credit card company will report monthly to the three major credit bureaus: Equifax, Experian, and Transunion.
Assuming you’re making monthly and on time payments, this will help you build credit over time. But, just like an unsecured credit card, there are fees and penalties associated with paying late. Secured credit cards also charge interest rates. A secured card shouldn’t be confused with a debit card because debit cards are linked to a checking account. However, some debit cards like Green Dot by Visa serve much like a checking account with perks similar to those offered by credit card companies, including cashback for online and mobile purchases.
What Happens to Secured Credit Card Debt in Bankruptcy?
Bankruptcy law provides exemptions that you can apply to protect your assets. These exemptions protect your property from the risk of being sold by a trustee to repay your creditors. By claiming an exemption, a bankruptcy filer can protect the equity in their personal and real property. To determine the amount of equity an asset has, subtract what you owe from the value of your asset. For example, if your car is worth $10,000 and you owe $6,000, the equity is $4,000. If the figures were reversed, say your car is worth $6,000 but you owe $10,000, then you have what is called negative equity and you wouldn’t need to worry about claiming an exemption because the amount owed exceeds the exemption value.
In the case of a secured credit card, a bankruptcy exemption (when available) may be applied to your available credit limit. Since the deposit with the credit issuer is likely minimal, most if not all of the deposit will be protected. However, just like all secured debts in a Chapter 7 bankruptcy, you must be current with your monthly payments to avoid a negative action by the credit card issuer.
It’s important to know that exemption amounts vary by state. For example, in Florida, if you own a home, the exemption amount for personal property is $1,000 and $4,000 if you rent. But in Arizona, the exemption is $6,000. If you aren’t sure how to apply exemptions, consult with an experienced bankruptcy lawyer.
Chapter 13 and Secured Credit Cards
A Chapter 7 bankruptcy is known as a liquidation bankruptcy and it’s the most common type of bankruptcy case filed. To qualify for Chapter 7 bankruptcy, you must pass the Chapter 7 means test which is partially based on the average of your last six months of income. If your income is too high or you need to protect nonexempt property, then you can still proceed with a Chapter 13 bankruptcy filing. The specifics of your financial situation will determine whether a Chapter 7 or Chapter 13 bankruptcy is best for you.
Chapter 13 is known as a reorganization of debt since it involves a 3-5 year repayment plan that must be approved by the court. Chapter 13 provides several benefits that Chapter 7 doesn’t, including catching up with payments on secured debt like a mortgage or car payment. With Chapter 13, your secured credit card payments will be included in the 3 to 5-year plan along with your other secured and unsecured debts.
Using a Secured Credit Card to Rebuild Your Credit After a Bankruptcy Discharge
Bankruptcy will help wipe out your debt and get your life back on track financially. However, after you have eliminated your debt, you will need to take steps to rebuild your credit. Filing for bankruptcy will temporarily hurt your credit score and having good credit is important. Without it, it’ll be very difficult to buy a new car or home. Even most car rental companies perform a credit check before they will approve your request for a rental car.
Bad credit may even prevent you from being approved to rent an apartment. To determine your creditworthiness, lenders consider your credit score record. After filing for bankruptcy, your credit score will drop, but by the time you filed for bankruptcy, chances are that you had already fallen behind on your payments and your credit score was already negatively impacted. As a result, filing for bankruptcy isn’t the end, it’s a new beginning. After receiving your discharge, you can take immediate steps building credit. People sometimes think it’s impossible to get approved for new loans after filing for bankruptcy, but that’s not true, it just takes some time and effort.
To improve your credit, there are several steps you’ll have to take. For one, you’ll have to make your payments on time. Late payments appear on your credit report and that hurts your credit score. Your credit utilization score is also important. That’s determined by comparing your credit limit to the amount owed. The larger the gap between the credit card balance and the credit limit, the higher your credit score will be. As time goes by and you make more and more payments on time, your credit score will improve and so will your credit limits.
If you’re unable to get a new credit card, consider a secured credit card. Remember, a secured credit card works just like an unsecured card (even though it’s easier to obtain a secured credit card if you have poor credit), so the creditor will report monthly to the credit bureaus. If your payments are timely, this behavior will improve your credit score. As time goes by, your credit history will continue to improve and you may qualify for an unsecured credit card.
To use your secured credit card effectively, use it to pay for your regular monthly expenses such as your grocery bills and utilities, then pay off the balance at the end of the month. Avoid using your secured credit card for non-essential items or luxuries. By making timely payment and using less than 30% of the overall credit limit, you could see your credit score improve.
What to Consider When Selecting a Secured Credit Card
When you’re researching for the best secured credit card, start with reputable lenders like Citi, Discover, Mastercard, and Visa. You can also consider your local bank or credit union if you already have an account opened with them. Credit unions generally offer secured credit cards for customers. If you're receiving offers from lesser-known lenders, investing in a few minutes of research can save you lots of time, money, and headaches.
A good place to begin your research is the Better Business Bureau (BBB) or your state attorney general’s website which will have sections devoted to consumers and finance. Each of these platforms will allow you to access the complaint history of companies you’re interested in working with so that you can spot any potential scams before you commit. Compare the different lenders for the best interest rates, including intro rates, and those that require small initial deposits, so you don’t have to wait too long to start rebuilding your credit. Some lenders will even offer perks such as cashback, rewards program, or even waiver of annual fees.
For example, the Opensky card is a secured card that offers a refundable security deposit, so when you close your account, your deposit - which is guaranteed by the FDIC - will be returned to you. Opensky doesn’t require a credit check either, so you can start building your credit immediately. The Capital One Secured Mastercard requires a minimum deposit and you’ll be automatically considered for a higher credit line after 6 months. The Capital One Secured Mastercard requires security deposits starting at $49, $99, and $200. Even with the minimum security deposit of $49, your credit line will automatically be $200.
There are also several secured Visa cards you can compare that have security deposits ranging from $200-$300 with no annual fees. The different card issuers have additional information regarding their products and services on their application pages, including important information regarding monthly reporting. With so many choices and a very competitive industry, research and compare to find out which is the best secured credit card for you.
Whenever you’re applying for credit, whether for a credit card or loan, there are some realities you’ll want to proactively consider. First, always confirm the interest rate. High-interest rates will only cost you more money in the long run and put you at risk of falling behind in your payments. Read the fine print in the cardholder agreement to confirm you’re not being offered an introductory interest rate (or intro rate) that will increase significantly after the limited time offer expires. Also, avoid lenders with application fees and high annual fees. Additionally, since the point of getting a secured credit card is to improve your credit score, any lender you choose to work with should honor the practice of reporting to the three major credit bureaus. The lender should also offer a way for you to track your payments and purchases through its website. If your secured credit card is administered by a reputable lender, you should be able to qualify for an unsecured credit card after proving your creditworthiness.
Other Ways Someone Could Rebuild Credit After Their Bankruptcy Discharge
You can start to rebuild your credit at any time after bankruptcy. Since improving your credit takes time, the general rule is the sooner you start, the better. Besides secured credit cards, some banks will offer credit-builder loans that work the same as a secured credit card. You simply borrow against the money you have deposited with the bank.
Reputable companies will likely be making you credit card offers some time after you file for bankruptcy. While the initial credit line limit may be low, as long as you make timely monthly payments, your credit limit will increase. Gas station credit cards are usually one of the first companies to offer credit after bankruptcy.
You can also become an authorized user on someone’s credit card, but that comes with risk. While as an authorized user you aren’t responsible for the debt, if the main borrower has late payments or defaults on the credit card, this will affect your credit score. So, you should discuss with the cardholder whether their credit card accounts are in good standing and if they have a positive payment history.
A better choice may be getting a co-signer for your credit card or unsecured line of credit. If the co-borrower has good credit, you should qualify for a credit card with a higher credit limit and a better interest rate than you could obtain on your own. However, co-borrowers are responsible for the debt, so it may be difficult to have someone apply for a loan with you. Whether using a secured or unsecured credit, you should avoid any late payments and try to keep the balance on your account low as compared to the credit limit.
Because bankruptcy gives you the opportunity for a fresh start, it’s only the beginning of your financial journey, not the end. Having good credit is important whether you are hoping to buy a car or home in the future. But, to get good credit, you’ll need to exercise responsible use of your credit cards and avoid certain pitfalls like overspending. So, plan a budget, start saving money by opening a savings account, keep track of your expenses, and work towards rebuilding your credit. Make sure to pay on time each month and preferably pay more than the minimum payment. If your credit history is preventing you from qualifying for an unsecured credit card, then take advantage of secured credit cards as a way to rebuild your credit after filing for bankruptcy.