How to Rebuild Your Credit Score After Bankruptcy
What's done is done.
You've taken the necessary steps to declare bankruptcy and you're coming out of it with a fresh start.
While most of your debts may have been discharged, there is one major downside (which you may have expected).
Your credit score is absolutely terrible.
Access to loans and credit is an important part of modern financial life. Once you've gone through bankruptcy, you’ll want to follow up -- immediately -- with the process of rebuilding your credit.
This can take work and time but is certainly essential.
Find out how you can begin fixing your credit most effectively so that you'll be able to take out loans again.
What Bankruptcy Does to Your Credit
When lenders lend you money, they expect you to pay the loan back. Credit scores are designed to help lenders determine how likely you are to pay back money that you borrow.
Declaring bankruptcy is admitting that you won’t be able to pay back your loans.
You’ll see a huge drop in your credit score.
The drop can be as large as 200 points or more.
This is enough to drop even an excellent score into poor or fair territory.
That significantly restricts the types of loans and credit cards that you can qualify. Even that is before considering the fact that many lenders won’t lend to people who still have a bankruptcy on their credit report, regardless of their credit score.
Depending on the type of bankruptcy you declare, the record will remain on your credit report for 7-10 years.
- Chapter 7 bankruptcy, which discharges most loans rather than setting up a payment plan, will stay on your report for ten years.
- Chapter 13 bankruptcy, which mostly restructures your loans, stays on your report for seven years.
While your bankruptcy remains on your credit report, it will continue to have a negative effect on your credit score and lenders will be able to see it when they check your credit history.
As more time passes after your bankruptcy, it will have a smaller impact on your score until it falls off your report entirely.
How Do Credit Scores Work?
We’ve discussed credit scores a fair bit because they are an essential part of your ability to access credit and loans. Credit scoring may seem complicated at first, but they’re still important to understand.
Your credit score is a numerical representation of your trustworthiness as a borrower.
A good credit score means that you’re likely to pay back any money that you borrow. A bad credit score means you’re likely to not be able to pay back a loan.
Credit scores can range from 300 to 850 with 850 being a perfect score.
There are five factors that influence your credit score.
The first and most important is your payment history. Every time you make an on-time loan payment, your score will increase. Missing even a single payment, or sending a late payment, can have a large effect on your credit score.
The best way to build your credit is to always pay your bills on time. One of the best ways to do this is to set up automatic payments, which can ensure that you never miss a due date.
The second most important factor in your credit score is the amount that you owe. The more that you owe, the harder it will be for you to pay back a new loan. For that reason, having a lot of debt reduces your credit score.
This also takes the amount of debt you have relative to the amount of credit that has been extended to you. If you’re maxing out your credit cards, it will hurt your credit score. If you’re using just a small amount of your credit cards’ limits, it will be better for your credit.
The total length of your credit history, the average age of your accounts, and the number of new accounts you have also impact your score. The longer you’ve had access to credit, the better it is for your score. Similarly, the longer you keep your credit card and other loan accounts, the better. Bouncing from account to account can be bad for your score. Opening new credit cards or loans also dings your score.
Finally, the types of credit you’ve used have a small impact on your overall score. Having experience with multiple types of debt, like credit cards, personal loans, mortgages, or auto loans, will improve your score as it shows that you can handle different types of debt.
The better your credit score is, the more loans that you will qualify for and the lower your interest rates will be.
Different Ways to Rebuild Good Credit
Once you’ve declared bankruptcy, you should start working on rebuilding your credit score. The sooner you start, the sooner you’ll have a score that’s good enough to qualify for a loan.
The problem is, once you’ve declared bankruptcy, few lenders will be willing to trust you with a loan. That’s why one of the best tools to use is a secured loan.
1. Secured credit card
A secured credit card works just like a regular credit card does. You apply for the card and get a plastic card in the mail. You can use it to shop at the stores you frequent, receive a bill every month, and should do your best to pay it off in full.
Where a secured credit card differs from a normal credit card is that you have to provide a deposit when you apply for the card.
For example, if you are approved for a secured card with a $200 credit limit, you’ll be asked to provide a $200 deposit up front.
The lender will hold onto that cash as collateral.
You’ll still need to make payments as usual, but if you miss your payment, the lender won’t be at risk, as it can just take money out of your security deposit.
In this sense, you get access to a credit card without the lender accepting any risk.
Once you’ve used the card enough to prove your trustworthiness, the lender will return your security deposit to you.
Many secured cards charge significant application or annual fees, but there are free options out there. The best secured credit cards usually have:
- low annual fees
- low APRs
- low security deposit requirements
- reports to credit bureaus
- helps you transition to an unsecured card
2. Secured personal loans
You provide a security deposit to the lender, whether it be in the form of cash, the title to your car, or something of similar value.
You can use the loan as you please, but one of the most common strategies is to simply keep it in a separate bank account. Set up automatic payments and use the money you borrow to pay the loan back.
This will help you build up a history of timely payments, improving your credit score.
The downside of this strategy is that this will incur interest charges. There are free ways to rebuild your credit history, so look into those before considering this option.
3. Become an authorized user
You can also build your credit score by becoming an authorized user on someone else’s account.
Find someone who trusts you to make you an authorized user on their credit card account.
Many card issuers will begin report that card’s activity to your credit report. In this way, you can build a positive payment history without needing to get a card of your own.
4. Dispute inaccuracies on your report
Request a copy of your report and dispute any inaccuracies.
You’d be surprised at how common it is to see a delinquent account that doesn’t belong to you on your credit report.
Each bureau has its own process for disputing mistakes, so make sure to look up the proper process and follow it.
When you’re rebuilding your credit score, be sure to follow these tips.
Keep balances low
Keeping your balance low is important for two reasons.
First, a low balance is good for your credit score.
Maxing out your cards is the last thing you want to do if you’re trying to get a better credit score.
Second, keeping your balances low will help you avoid getting back into the situation that you were in when you first declared bankruptcy.
Patience is a virtue. Your credit score won’t improve overnight.
Again, it will take 7-10 years for your bankruptcy to fall off your credit report. It could take at least a year or two for your score to improve to the point where you’ll qualify for an unsecured card.
Be patient and remember that rebuilding your credit is a long game.
Track your score
Even though you’re patient, don’t be afraid to celebrate small victories. Any number of free services lets you track your credit score.
Sign up for one of these services and see how your score improves over time. It can be a good way to keep yourself motivated.
Regardless of why you declared bankruptcy, rebuilding your credit is an important step to take.
It can take quite some time, so the sooner you begin, the sooner you’ll see results.