Filing for bankruptcy is not a decision most people take lightly, especially since it affects access to new credit, home loans and even employment opportunities, not to mention the emotional impact filing for bankruptcy can have.
Nevertheless, more than 1 million consumers filed for bankruptcy during the 12-month period ending September 30, 2008, according to federal court statistics released in December. This compares to 775,344 filings over the same period the year before.
Bankruptcies can remain on your credit report for up to 10 years and can decimate your credit score by hundreds of points. But by adopting these strategies, you could boost your credit score and become creditworthy several years before the bankruptcy drops off your credit report.
- Take a reality check
- Check your credit reports
- Obtain a secured credit card
- Get an auto loan
- Bide your time
- Get multiple credit lines
- Be wary of credit repair services
1. Take a reality check
Rebuilding your credit score after a bankruptcy is far from being pain-free. It entails making an honest assessment of the reasons you filed in the first place and then taking action to establish positive lines of credit.
People claim bankruptcy for a number of different reasons. Job loss, serious illness and relying too much on credit all rank high on the list.
Regardless of the reason you wind up filing for bankruptcy, if you don’t do a thorough self-assessment of what went wrong, you could end up repeating the same behavior that got you into trouble in the first place — especially if it was due to financial mismanagement.
“Filing bankruptcy is supposed to be a fresh start,” says Stephen Snyder, credit expert and author of “Credit After Bankruptcy.”
“But in order to take advantage of the fresh start, you need to say, ‘OK, I overextended myself. I bought a Mercedes when I should have bought a Ford. My lifestyle was out of proportion. I need to scale back and live within my means.'”
Although there’s not much you can do when an unexpected illness or job loss drains your finances, certain voluntary spending habits should be avoided.
Compulsive behaviors that involve wagering sometimes get people into trouble with debt and can precipitate a bankruptcy.
“When I ask people what got you into this problem and they say ‘gambling’ and they live in Las Vegas, I tell them, ‘You need to move somewhere else. Because it’s just a matter of time that you’re back in the same place,'” Snyder says.
Similarly, the serial entrepreneur, who, despite repeated failure, insists on managing his own business to the detriment of his financial well-being, should probably assess the alternatives.
That individual, Snyder says, would probably do well to “consider getting a regular full-time job.”
“If they don’t fix that (source of financial problems), it’s just going to be a vicious circle that’s going to get worse and worse and worse.”
2. Check your credit reports
After a bankruptcy discharge, make sure that your credit report is accurate. After all, your goal is to boost your credit score quickly, and inaccurate information will only prolong the time it takes for you to score high enough for conventional credit.
“Make sure that lenders are no longer updating your account every month, making it appear as though the delinquency just happened last month,” says Ethan Dornhelm, principal scientist at FICO Scoring Solutions Division.
Debts that were discharged through bankruptcy should be accurately reported along with “good items” — including accounts that were “paid as agreed” — and any other accounts that you continue to pay on time that were not discharged in the bankruptcy.
For example, you typically cannot discharge federal student loans in bankruptcy.
Get a copy of your credit report and make sure everything is accurate. You are entitled to one free credit report every 12 months from each of the three national credit bureaus. You can get them all at once, or better yet, stagger them every four months so you can your report more frequently.
“If it’s not accurate, consumers have to contact the credit bureaus themselves and the bureau in turn investigates and contacts the creditor,” Dornhelm says.
Credit bureaus generally have 30 to 45 days to investigate your claim.
3. Obtain a secured credit card
“After you go through any kind of major negative (financial) event, the most important thing is to get back on the horse and not just abandon the credit system entirely,” says personal finance expert Emily Peters of Credit.com.
One of the most effective ways to boost your credit score after bankruptcy is to obtain a secured credit card, she says.
Secured cards are credit cards secured by a deposit account (usually a savings account) owned by the cardholder. The credit line is typically based on the amount deposited into the account. Deposits range from a few hundred dollars to a few thousand dollars, depending on the card.
Bank of America and Wells Fargo, for example, accept deposits from $300 to $10,000.
One caveat is that although these cards are still around, their numbers may be declining.
JP Morgan Chase announced it is discontinuing the secured credit card program initiated by Washington Mutual and closing those accounts.
“Secured credit cards are not a product currently offered by Chase,” says Stephanie Jacobson, a JP Morgan Chase spokeswoman. JP Morgan Chase acquired the deposits, assets and certain liabilities of Washington Mutual back in September 2008.
Jacobson says customers with funds in these accounts will receive a refund as well as a credit for a portion of the annual fee.
- Understand eligibility requirements. Some card issuers may not give you a card if your bankruptcy is too recent.
- Look for low annual fees, reasonable interest rates and reasonable service charges.
- Make sure the card reports to at least one of the three major credit bureaus. A card that reports to all three is better.
- Deposits should be FDIC-insured.
Consumers should also be wary of unsecured credit card offers that come in the mail. Many of those are likely to have unfavorable terms and may not help boost your credit score in the long term.
“Those cards were designed for people with bad credit to remain in very low-credit-limit situations for a long period of time at a high interest rate,” says Stephen Snyder, author of “Credit After Bankruptcy.”
“The whole idea in getting a credit card after bankruptcy is to prove that you are creditworthy again and to get as high a credit limit as possible with the lowest interest rate. You’re not really going to accomplish that with some of those unsecured card offers.”
With a positive payment history and no other negative credit blemishes, you could graduate to an unsecured credit card in a few years, according to Snyder.
4. Get an auto loan
Getting a post-bankruptcy auto loan without an exorbitant interest rate can be tricky, but if you’ve been repaying your credit accounts on time and keeping your overall utilization ratio low, experts say it’s possible to rebuild your credit score to a respectable level within two or three years.
“Within a couple of years you could have a score maybe over 650,” says personal finance expert Emily Peters of Credit.com. “A couple of years of due diligence will work.”
Auto loans are a logical next step toward rebuilding your credit because the loan is secured by the car, and lately, some auto lenders are more willing to give loans to people with less than perfect scores, she says.
For example, GMAC Financial Services announced in late December that it will extend credit to buyers with credit scores as low as 621. The previous floor was 700. And it’s not uncommon to see signs on car lots that say, “Bad credit? No problem!” These are desperate times for car dealers, after all.
But consumers still need to be just as wary about auto loan terms as they are with credit card terms because although you may be offered a loan, it doesn’t necessarily mean you’ll be getting a great deal. Be sure to shop around.
In January, the average interest rate for a 36-month new car loan for buyers with credit scores between 500 and 589 was 16.52 percent, according to MyFico. That would mean a monthly payment as high as $708 on a $20,000 auto loan.
“You’re going to get a lot of offers in the mail, but take a look at what’s out there and make some smart decisions,” Peters says. “You don’t want to get into something like a 32 percent car loan just to rebuild your credit.”
5. Bide your time
Generally, the more time that has elapsed since your bankruptcy discharge and the faster you establish a positive payment history, the quicker your credit score will start inching out of the basement.
The payoff to your credit score can come relatively quickly with the right financial management practices. That’s why it’s critical to start establishing positive credit lines immediately.
“If you’re doing all the right things, like staying current on payment obligations, opening new payment obligations and performing well on them, and keeping your balances low relative to your credit limit, your score can rebound from bankruptcy to a decent level where you can start qualifying for (unsecured) credit in around three years,” says Ethan Dornhelm, principal scientist at FICO Scoring Solutions Division.
But Dornhelm cautions that in this credit environment it could take longer than a few years to boost your credit score to acceptable levels if lenders remain skittish and keep raising scoring standards.
6. Mix it up with multiple credit lines
Having more than one type of credit line will help boost your credit score.
“You want to have a nice mix of revolving charges and installment charges,” says Dee E. Hoffman, executive director of the National Credit Restoration Alliance in Conroe, Texas.
“The point is most people with great credit scores probably have two credit cards from well-known, well-respected banks, a house payment, maybe a boat payment, and they keep those balances below 15 percent (of available credit) every month.”
About 10 percent of your credit score is calculated based on the types of credit you use (i.e., credit cards, mortgages, installment loans and retail accounts), according to MyFICO.com.
Another 10 percent is based on new credit accounts — which can include credit lines established following your bankruptcy. However, exercise caution when opening too many new accounts all at once because you could potentially lower your credit score by lowering the average age of your credit accounts. This is especially true for consumers who went into bankruptcy with already thin credit files.
Post-bankruptcy consumers may want to avoid retail accounts because they usually have low credit limits and can get the cardholder into high utilization ratios very quickly, according to Hoffman.
“Unless that’s the only card you can get, I would advise not getting it unless you can go in there and charge a cheap item and pay it off each month,” he says.
Stephen Snyder, credit expert and author of “Credit After Bankruptcy,” believes retail cards may be useful.
“I’ve always pooh-poohed retail credit because it’s a small part of the credit mix and the interest rates are high, but it’s important to have the right mix for your scores,” says Snyder. “I’m low key on retail but it’s still important to getting back your credit score.”
Once your financial house is in order and your credit score goes up, you could qualify for an FHA loan. Generally, it takes about two years after a bankruptcy discharge to qualify for an FHA loan.
“It’s a great time to mortgage a home because FHA limits are the highest they’ve ever been and government is certainly the way to go for a more recent (bankruptcy) filer,” Snyder says.
Although the FHA program does not officially use credit scores to qualify a loan, individual lenders may.
“Most of the lenders now require at least a 580 score to get an FHA mortgage and some go down as far as 550,” he says.
7. Be wary of credit repair services
Some credit repair and credit “doctor” companies make grandiose claims that they can clean the slate and repair your credit file, often for a substantial fee.
However, many of these organizations turn out to be scams that will take your money and leave you with a still-damaged credit file, according to the Federal Trade Commission.
Some of these companies claim they can remove negative information from your credit file. This is untrue if the information is accurate. Only time will cause those entries to drop off your credit reports.
In general, negative information can stay on your credit report for up to seven years, with some exceptions.
The public record of the bankruptcy filing itself is noted separately from the negative account information associated with it. For example, Chapter 11 and 7 bankruptcies remain for up to 10 years on your credit report and Chapter 13 bankruptcies can remain for up to seven years, but the individual accounts included in any consumer bankruptcy should drop from your credit report after seven years, according to MyFICO.com.
The dubious nature of claims made by some credit repair operations has caught the eye of the government. The FTC, along with 24 state agencies, cracked down on almost three dozen companies in October 2008.
Bottom line: It probably took you awhile to get into bankruptcy in the first place and it will take awhile to repair your credit file and boost your score. And while some of these organizations may legitimately have consumers’ interests in mind, many of them don’t.
“I think a lot of them are actually aligned with the creditors and they will work with you as long as you are paying,” says Dee E. Hoffman, executive director of the National Credit Restoration Alliance in Conroe, Texas. “But the moment you are in distress, you’ll find they have the same face as the creditors.”
The FTC alerts consumers about what to look out for when considering a credit repair service.