Consumer Comeback Blog

How to repair your credit score after bankruptcy

Bankruptcy hurts. It can seem like the end of the world to some. Picture everything you once owned gone in the blink of an eye. And starting over doesn’t just seem difficult, it truly is difficult. You’re a credit liability. And creditors will see it that way…for a while.

But bankruptcy isn’t the end of the world. You can come back and start to rebuild that trust with creditors. It isn’t always easy, and it takes some time, but if you’re able to learn from your previous mistakes, it can be done. Here’s how:

How bankruptcy affects your credit score

Bankruptcy is the single most damaging thing that can appear on your credit reports. For a while, getting any kind of loan or line of credit will be near to, if not completely, impossible. And once it’s there, it’s going to be there for a while. Over time, however, the damage bankruptcy does to your credit score will start to diminish, but only if you’ve kept the rest of your records clean for that time.

How much it impacts your score also depends on the type of bankruptcy was filed. Because with Chapter 13 bankruptcy you still have an opportunity to pay off a portion of outstanding debts and keep some assets, the effect isn’t quite as harmful as Chapter 7 (complete liquidation). Also, Chapter 13 can be removed from your credit reports in as little as 7 years after the debts are paid, while Chapter 7 it will remain for the standard of 10 years.

Before you begin: Educate yourself & learn from past mistakes

The first and most important step to recovering from bankruptcy is learning from the mistakes that got you into the mess in the first place. Get acquainted with your credit reports, they’re free once a year. Look over your past history paying close attention to the growing amounts of debt over time and the increasing late payments that followed. It’s not hard to see how quickly things get out of hand. Next, learn how to manage your reports: monitor potential negative marks, getting errors removed, etc.

This is also a good time to reflect on your relationship with money and the possessions you want to buy with it. It’s a time for hard truths and, in most cases, a total change of attitude towards spending. If you aren’t brutally honest with yourself or willing to make sacrifices to your lifestyle, you’ll be back in bankruptcy court before you know it.  It’s a great time to start being frugal.

Phase 1: Budget and save

Because immediately after bankruptcy getting a line of credit won’t be much of an option, the only thing you can do [at first] is focus on your income, spending, and develop a personal budget. First and foremost, make sure you are able to pay your remaining current bills (e.g. rent, utilities, student loans, etc.) on time. The very last thing you want during this stage is any more negative marks on your credit reports. Next, create and maintain a budget including these bills and all your other regular spending.

Keep. Track. Of. EVERYTHING.

In the first couple of years you need to also focus on building savings.  Mostly, because you won’t have the option of using credit for any larger purchases you’d like to make. But even more importantly, however, is that if you aren’t able to budget and save money, you aren’t ready to start using credit.  If you can’t save, it means you’re spending all the money you are making, and adding credit to that will only put you over the top. Another reason savings will be important is because when you are ready to take out a loan, creditors will want a significant down payment due to your poor credit standing (especially if you want a lower interest rate). So during the first couple of years after bankruptcy, focus on spending less money than you make and set the rest aside for larger as well as future purchases.

…Then you’ll be ready for phase 2:

Phase 2: A fresh start to your credit history

Once you’ve figured out a personal budget and have started to build up some savings, it’s time to start building a positive credit history again. This isn’t something you should jump into lightly, however. The key, here, is to start out slow and get used to utilizing credit without changing anything about your budget.

Something you need to be careful of, in this stage, is requesting too much credit. Applying for credit cards and loans can hurt your credit score, even if you are rejected. And that’s clearly not something you’ll want to do when the goal is to increase your rating. Instead, look at some other [beginner] options, like secured credit cards. These cards set your “credit limit” to the amount of an initial deposit. They’re a great way to build up a trust with credit reporting agencies as well as a great way to get used to making regular payments on a credit card. Only use it for things you have the cash to pay for and ***get used to paying the entire balance each month***.  If you can’t do this, stop using it immediately until you can, it’s that important.

Phase 3: Graduating to more serious credit usage

After a couple of years of using limited credit following a bankruptcy, you can’t expect your credit score to improve a whole lot. But after showing responsible use of a secured credit card, you might be ready to graduate to more beneficial credit-history-building revolving debt (i.e. typical credit card). Even though interest rate offers will be high, if you continue to pay the balance in full each month, you can avoid paying interest altogether. Stick to the plan: use the card more-and-more for everyday purchases, and don’t change anything about your budget. Even for big purchases, for example: save up for a TV you want and when you have enough cash, use the credit card for the purchase and pay it off right away (with the savings).

Something to be weary of before you can graduate to more serious loans is interest rates.  One of the major drawbacks for a poor credit rating is the higher interest rates. So before you consider taking a loan, mortgage, or even keeping a balance on a credit card, be sure you’ve built up your credit enough that you don’t pay the highest (poor credit) rates. Yes, this could take years, but the longer you can hold off, the better off you’ll be. Just continue to save, and that will help you out with the next step:

One way to reduce interest rates on loans is by making a larger down payment.  This is why savings is so important early on.  With secured loans, like mortgages, the more principal you can pay, the safer the loan will be for the bank. If you can afford 20% down, you usually get the preferred rate [sometimes] even if you don’t have the best credit score. High interest rates will cost you money in the long-run. More dangerously, it can become the driving force for repeat problems. If you can’t get a preferred interest rate consider waiting to make the purchase (and continue to save) until you can.

Phase 4: Full recovery

10 years after filing bankruptcy you can have a near perfect credit rating with no negative marks. Not only will the bankruptcy be off your reports, but most of your old closed accounts (with blemishes) should also be gone. Also, if you’ve been responsible since, making payments on time, 10 years is a relatively long time to build a good amount of positive credit history.