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Special Report
Bounce back fast after a bankruptcy
Carefully rebuild your credit and you could qualify for almost-normal rates, even a mortgage, in a year or two. Here's what you need to do.
By Liz Pulliam Weston
Anita Burleson has had trouble getting credit since her bankruptcy two years ago, but she knows thats not true for every filer. The fact that there are repeat bankrupts tells her that.
When I was in bankruptcy court, there was a couple that had filed for bankruptcy twice prior to this one, said Burleson, who lives in Emerson, Ark. How could they get enough credit to get them into this much debt (three times)?
Actually, almost anyone can get credit soon after a bankruptcy. Its just a matter of knowing how.
Its true that bankruptcy deals a devastating blow to your credit and your credit score, the three-digit number lenders use to gauge your credit-worthiness. But the effects dont have to be lasting. Long before the bankruptcy drops off your credit report, you could be qualifying for loans with good rates and terms.
Nothing is forever
Ken Cordes of Chicago filed Chapter 7 liquidation four years ago after unemployment and overspending caused him to rack up more than $20,000 in credit card and other unsecured debt. Today his credit scores range from 655 to 719, decent numbers that are just below the cutoff to get most lenders very best rates.
I recently applied for a secured credit card (usually reserved for people with troubled credit) and was informed that I qualified for an unsecured card -- a possibility I hadnt even considered, Cordes said. While I am going to be very careful with my new credit (card), I am heartened that creditors consider me an acceptable risk.
If youre a recent bankrupt, here are two things you need to keep in mind:
- Nothing in credit is forever. A bankruptcy legally can remain on your credit report for up to 10 years, but its effect on your credit score can start to diminish the day your case is closed -- if you adopt responsible credit habits such as paying your bills on time, using only a small portion of your available credit and not applying for too much credit at once.
- You have to get and use credit to build your credit score. Living on a cash-only basis may be a smart choice for those who really cant handle credit. But if you want to rebuild your credit score, you cant sit on the sidelines.
Learn from your mistakes
Although repeat bankrupts show that getting credit after a Chapter 7 or 13 filing is possible, you shouldnt want to emulate those who file more than once.
At first glance, people who file more than one bankruptcy seem to be beating the system: They run up big bills and then walk away.
Think about it a little more, though, and youll see these multiple bankrupts are really defeating themselves. Their debts and credit history often mean theyre paying out big bucks in high interest payments during the time when theyre prohibited from filing another bankruptcy (typically six years). And most people cant file for Chapter 7 liquidation if they have significant assets to protect, such as home equity or savings. So these folks who are repeatedly going broke often have little to show for all the money thats leaving their pockets. Instead of building wealth over time, theyre losing ground.
Instead, use your bankruptcy as a wake-up call to figure out whats wrong with your finances and fix it.
- If your problem was overspending, youll find plenty of information on this site about creating and sticking to a budget. (See our Decision Center: Get a budget, get a life.)
- If you didnt have enough savings to survive a job loss or other setback, get serious about establishing an emergency fund.
- If you were sunk by medical bills, seek a job with insurance coverage or check to see if your state offers coverage.
Clean up your credit report
One of Burlesons biggest problems is that her credit reports still show several accounts as open and overdue -- when in fact they were closed and the obligations wiped out as part of her bankruptcy.
In order for her credit to recover, she needs to contact the credit bureaus and insist that those accounts be properly reported as included in bankruptcy.
If you have other serious mistakes on your credit report, those need to be corrected as well. Your credit score is based on information in your credit report, so errors on your report can seriously dampen your score.
Get a secured credit card
You need two types of credit to quickly rebuild your credit score:
- Installment: Auto loans, student loans or mortgages
- Revolving: Credit cards or home equity lines of credit
Most recent bankrupts have trouble qualifying for a regular, unsecured credit card. So the best solution usually is a secured card, which generally gives you a credit limit thats equal to an amount you deposit at the issuing bank.
Typically, thats $200 to $500, which may seem like a pittance compared to the credit limits you enjoyed before your bankruptcy. But dont make the mistake of using your available credit. Maxing out your credit cards hurts your credit score.
You dont want to charge more than 30% or so of your credit limit, and you want to pay the balance off in full each month. Light, regular use of a credit card is what helps build your credit.
And contrary to what you might have heard, you typically dont need to carry a balance or pay credit-card interest to build your score, since the leading credit scoring formula doesnt distinguish between balances that are paid off and balances that are carried month to month. Get in the habit now of not charging more than you can pay off every month; your credit score and your finances will be the better for it.
You also shouldnt just grab any secured card. Look for the following:- No application fee and reasonable annual fee. Some secured cards tack huge upfront and annual charges onto their accounts; you dont need to pay these to build your credit.
- Reports to the major credit bureaus. Youre not doing your credit score any good unless your payment history is being reported to the three major bureaus: Equifax, Experian and TransUnion. Call and ask if the card issuer regularly reports to all three before you apply.
- Converts to an unsecured card after 12-18 months of on-time payments. Good behavior should get you upgraded to a regular credit card within a year or two.
Get an installment loan
If you still have student loans (which typically arent dischargeable in bankruptcy), you can use them to rebuild your score. Make your payments on time, all the time, and try to pay more than you owe whenever possible. Next to making on-time payments, paying down your existing debt is one of the best ways to improve your credit score.
Cordes of Chicago took this to heart, making double or triple the minimum payments required to retire his $23,500 student loan debt within three years of his bankruptcy filing.
The fact that I had to repay my student loans (rather than having them discharged) might have helped me in the long run, Cordes said.
Cordes' credit has recovered enough that he's scheduled to close escrow on a condo purchase later this month. He qualified for a 6.4% interest rate on a 30-year fixed mortgage.
Another option: a mortgage. Interestingly, it can sometimes be easier to get a mortgage after a bankruptcy than to get other types of installment loans.
You may be able to qualify for a high-rate loan as little as six months after a bankruptcy, but youre probably better off waiting until you can qualify for an FHA loan. You can typically get one just two years after your bankruptcy case has closed, as long as youve maintained good credit habits since then. FHA loans have interest rates that are usually only half a percentage point higher than regular mortgage rates.
Just make sure you really can afford a home before you buy one. Many people wind up in bankruptcy court because they stretched too far to buy a house and cant keep up with all the attendant costs of homeownership, said bankruptcy expert Elizabeth Warren of Harvard University. (See Dont bite off too much house for more details.)
Auto loans can also help you rebuild your credit -- just be prepared to pay nose-bleeding rates at first.
"My first vehicle out of bankruptcy (had an interest rate of) 21%," said Chance Nelson of Indianapolis, who applied for the loan just a few months after his debts were discharged. "After paying this for about 2 years, I went and traded it in and purchased another (at) 13.99%."
Nelson refinanced this second loan a year later at 7.95%. Today, five years after his bankruptcy filing, Nelson is paying a reasonable 6% rate for his auto loan.
If you go this route, try to make a big down payment and choose a loan that doesnt have a prepayment penalty. That way, you can refinance the car to a lower interest rate as your credit improves.
Just dont forget: The key is to make sure all your payments are made on time, all the time.
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