You’ve declared bankruptcy. Now what?
You have a fresh start, and some new challenges. Your credit rating, which probably wasn’t all that great already, has taken a hit. The bankruptcy will stay on your credit report for up to 10 years. Lenders see you as a bad risk because you’ve legally written off at least some of your past debts. For a period of time you may not be able to get a loan or credit card. Once you do, the interest rates and fees attached will be punishing.
“The purpose of filing is a safety valve,” says Roger M. Whelan, resident scholar of the American Bankruptcy Institute, a nonprofit professional organization. “Thank God, the day in which it was like wearing a blazing star on your forehead is over.”
If you’ve filed a Chapter 13, that means you’re paying off some of your debts in what’s known as reorganization. For three to five years, the court allows you a set amount to live on and a court-appointed trustee divides the rest among your creditors each month.
That means a very no-frills lifestyle. Sometimes it means changing the basics in your life, like how much you pay for shelter and groceries every month. And you can’t take on new debt like a credit card or car loan without the court’s permission. At the end of reorganization, your obligations are gone and your money is yours again. But the fact that you’ve declared bankruptcy, even though you paid back at least some of your debt, will stay with you for five to seven more years.
If you filed a Chapter 7, you walked away from most of the debt. Your salary is yours, if you have one, but the bankruptcy stays on your credit reports for 10 years. You have to start living on cash, rather than counting on any form of credit, and building an emergency fund is key. In addition, creditors may view you as a worse risk than someone who filed a Chapter 13, which means high interest rates and punitive fees when you do get loans or credit.
The 800-pound gorilla: getting credit
It’s the double-edged sword of post-bankruptcy life: mismanaging credit may have gotten you into trouble (or just magnified other problems), but you have to get credit to rebuild your financial life.
After your bankruptcy has been discharged, right away for a Chapter 7 or after reorganization for a Chapter 13, you need to re-establish good credit. The rule of thumb: there are no rules. How fast you build back your credit will depend on a lot of factors that vary widely.
It also depends on what resources you have. Obviously, if you have a high-dollar income, you have an edge. If you managed to hang onto your house, mortgage payments on time will improve your credit report. (Many apartments don’t report to credit bureaus, so those payments will keep a roof over your head but won’t help rebuild your credit, says John Ulzheimer, business development manager for MyFico.com, a division of Fair Isaac Corp., the company that developed credit scoring.)
Ironically, people who file a Chapter 7 may have an easier time re-establishing credit, says Henry Sommer, an attorney and author of “Consumer Bankruptcy: the Complete Guide to Chapter 7 and Chapter 13 Personal Bankruptcy.” “While you’re in a Chapter 13 [reorganization] your options are somewhat limited in terms of credit.”
When the discharge is complete you can start rebuilding your credit while someone who went through a Chapter 7 at the same time is already well on his way to repairing his credit.
Bankruptcy experts insist that attitude and persistence can make a difference.
“The consumer who’s going to recover faster is the consumer who jumps back in,” says Ulzheimer.
“Financial capacity is one thing,” says Tahira K. Hira, a professor at Iowa State University who specializes in consumer economics and family finance. “Mental or attitudinal capacity is the other thing.”
So if you build a savings account, carry no debts and have an emergency fund, you’re saying, “Look, I can control my behavior,” she says. “It depends on how good a salesperson you are and how good your behavior has been.”
But you have to shop lenders, “and there will be a price attached, which is higher interest,” says Hira.
In the first six months after your bankruptcy discharge, you want to demonstrate you’ve learned from your financial mistakes. You’ve got to be a model citizen from here on when it comes to financial management. That means making all your payments on time and building up a savings account for those inevitable rainy days. If you’ve managed to keep a credit card through the bankruptcy, use it once in a while to buy a necessity and pay it off immediately.
If you don’t have a credit card, establish good financial habits and apply for a secure card. “A general guideline would be six months [after your discharge],” says Whelan, a bankruptcy judge for 12 years.
You’ll put money in an account and the credit card company will give you a credit limit of that same amount. When the bill comes in, you pay it, as you would a normal card. You get the deposit back only when you close the account or switch to an unsecured version. Some card companies may also be willing to give you a credit limit higher than your actual deposit, says Curtis Arnold, founder and spokesman for Cardratings.com. Tip: Look for a card that reports to one, and preferably all, of the credit bureaus.
The good news: Many secured cards report as unsecured cards, says Arnold. “And assuming your account’s in good standing, once you’ve had it for a year you should start getting halfway decent offers on unsecured cards.”
Some smart shopping tips: Look for names you recognize and the lowest fees and rates you can find. And only consider a card that bills any fees to your card or bills you directly after you receive it. When they want money up front, chances are it’s a scam, says Arnold.
“Generally, we say that if you get a secured card, usually within six months to a year of good payment you can qualify for an unsecured card,” says Arnold. But don’t apply for more than one every six months, he says. Otherwise the inquiries will zing your credit. And be prepared for sticker shock with APRs from the high teens up to the 20s, he says.
One of the biggest problems with bankruptcy is that borrowing money is going to cost more for a while. A lot more. If you pay off the cards every month, you won’t feel the sting of higher interest rates. But subprime lenders are levying a host of fees, both one-time and annual, just for the privilege of carrying their cards.
“Usually they tack on application fees, processing fees and who knows what,” says Arnold. “It’s not uncommon to get hit with $100 to $300 that first year and $100 to $200 a year ongoing. And this is the industry standard.”
But you can win your way back with smart spending habits. “If you keep your nose clean and make your payments, within 24 months you can probably qualify for a halfway decent unsecured card,” says Arnold. Granted it won’t be the 5 percent APR you see on TV ads, but you might get one for 10 percent, he says.
If you’ve been through bankruptcy, you want to keep an eye on your credit rating score. Appearing on your credit reports, your score predicts the likelihood you will be delinquent on a bill in the next two years, says Ulzheimer.
Yes, bankruptcy will zing your score. “But most people who file have delinquencies and issues already on their credit report,” he says. “As such, the score has already taken a severe hit.”
Because everybody and his brother is looking at your credit reports these days, bankruptcy may touch parts of your life you hadn’t even considered. It could send your insurance rates up. “Credit is one of the factors that many insurance companies use in pricing their policies,” says Jeanne Salvatore, vice president of consumer affairs for the Insurance Information Institute.
If you’re facing a Chapter 13 and you have kids in private school, the courts may make you put them in public schools, says Whelan.
“The judge has to set [the filers’] standard of living,” he says. And a lot will depend on the judge and what he or she sees as necessary living expenses. However, there is some latitude. For instance, if a child has learning disabilities and needs a special private school, that would be a different matter, Whelan says.
While it’s illegal for employers to discriminate against someone who’s declared bankruptcy, many employers do look at credit reports before hiring or promoting. “If you have two people who are equally qualified, it’s hard for it not to enter the picture,” says Hira.
One thing you can do: If there was a compelling reason for your bankruptcy, such as a divorce, business failure or sick child, list that on your credit report. Your notation has to be 100 words or less. It won’t affect your credit score, but in cases where there is a judgment call like employment or insurance, it could help you.
There is also human nature to consider. Bankruptcy records are public information. And with this the age of computerization, “It’s very difficult to keep it private,” says Whelan. In addition, if you are having your Chapter 13 payments taken out via payroll deduction — a favorite of the courts, says Whelan — then at least one person in your workplace will know about your financial situation. (Another option is to have your check directly deposited and an immediate bank withdrawal made the same day to avoid getting your office involved, says Hira.)
Your financial future
Any bankruptcy is difficult. And most people who file have been fighting financial problems for at least two to three years. “And there’s a psychological unhappiness about doing it,” says Seattle bankruptcy attorney Ken Weil. “It’s an admission of failure. Nobody is ever happy to come see me.”
In addition, those who file Chapter 13 are looking at several years on a strict money diet.
“What I tell clients before they file: ‘You’ll feel wonderful when you file,'” says Weil. “‘You’re dealing with a problem that’s been beating you up for so long. This lasts up to six months. Somewhere on the back end — 30 months out — you can see the light at the end of the tunnel. And at the end you feel fantastic. But what I find is that somewhere in the middle there is going to just be a horrible point. [You feel] I can’t do this anymore.'”
The best news: Time heals. Sure, it takes a decade for the bankruptcy to fall off your credit report. But if you aggressively practice good credit, the farther out you get, the less it will matter. That means lower rates, lower fees and better deals on car and home loans.