Credit After Bankruptcy
One of the common questions clients ask is, “Will I be able to establish credit after bankruptcy?” The short answer is, “Yes!” The slightly longer answer is it helps to understand how they compute credit scores, and the relationship between bankruptcy and credit.
Credit Scores, or What We Guess is in the FICO score secret sauce
No one knows for sure how they computer FICO scores. It’s kind of like the secret formula for Coca-Cola or the Colonel’s secret herbs and spices. However, some educated guesses include the following factors, assigned mysterious weights:
- available credit
- percentage of available credit used or maxed out
- recent performance – are you current lately
- payment history overall
- length of credit history
- new accounts
So it’s possible that you were outstanding and current for years (history), but if you’ve been wobbly the last 12 months (recent), your score goes down. Plus your credit utilization gets higher as you get more and more maxed out and approach your credit limit.
Now look at the flip side of that coin: A bankruptcy this year would hurt the score (recent negative mark). However, what you do next year and the year after help put the bankruptcy in the rear-view mirror and are more recent. So bankruptcy and credit are intertwined, yes, but paying on time the credit after bankruptcy will have a greater impact on the future than the bankruptcy itself.
The Credit Report Hit
Yes, your credit report will contain a bankruptcy, and that will be bad. And it will be reported for ten years after filing. The good news is, that is only five years after the Chapter 13 bankruptcy discharge.
It is largely a myth that a scarlet “B” on your credit report will prevent you from ever getting credit again. This myth is largely perpetuated by credit card companies. Yes, the same companies that helped lure you into credit card debt by constantly drumming into your head that it was good to spend money and buy things; extend to you a higher credit limit; tell you that you are “pre-approved”; give you checks for thousands of dollars to turn into cash immediately; and that you can transfer balances to them with a low introductory interest rate. The lie is that bankruptcy means that you won’t get credit again.
Bankruptcy and Credit: They Want You Back
The truth is just the opposite. We live in a capitalist society. There are too many companies in business to make a profit. And yes, you can help them make that profit. This win-win situation is how you re-establish credit after bankruptcy.
Firstly, realize that you can help them make a profit. With a bankruptcy on your credit report — even a new one — one thing happens immediately that makes you more attractive to a prospective lender: you suddenly have no debt. With no debt, you are all of a sudden in a position to repay the next debt you get. The same cannot be said if you have a mountain of debt before bankruptcy.
You’ve Used Your ‘Get out of Jail Free Card’
Secondly, after a bankruptcy, you are a lower risk, since you cannot file bankruptcy immediately again. Typically, you need to wait eight years after filing a Chapter 7 bankruptcy to file another one. The lenders know this, and know that if they lend to you after a bankruptcy, that you will be around for at least five or six years. This is time that they will make their profit. And again, this is what they are in business to do.
How, though? How do you help them make a profit? It’s all in the mix, part of the process of your re-establishing credit with your new fresh start.
For starters, acknowledge that you will be paying extra money to get a new start with your credit. This is ok, though. Remember, they are taking a risk on you. All they know about you is that you just wiped away a bunch of debt from companies just like them. They’re a little skittish, so for comfort, you will pay for the privilege of starting over. This will show up in the form of: monthly charges, application fees, and, of course, higher interest rates.
Accept Some (Not All) Offers
Additionally, accept some offers. Not too many. Just a few. Yes, there will indeed be offers. You’ll be surprised to find that you will get offered credit cards not long after your bankruptcy discharge. Higher interest rates and maybe even a security (ie: your own cash which you’ll be charging against) may be part of the bargain, but this is how the process starts. You’re a blank slate on paper. All they know about you is that you just wiped the slate clean. Let them have their reassurances (but reasonably, of course).
(Surprisingly, it will be easier to buy a car within the first year after you file BK, and you can qualify for a mortgage after bankruptcy one year after the discharge — two years after, you will be eligible for a mortgage at the lowest and best interest rates. If you doubt this, call a few mortgage brokers and ask them.)
Use Credit After Bankruptcy Responsibly
After that, use these credit cards, but in moderation. Use them not because you have to, but because they are credit-rebuilding tools. Just a few purchases a month, and certainly not anywhere near your new (lower) credit limit. You’re using them. They’re using you.
Pay Them On Time
Lastly, make your monthly payments. Here is the kicker, though: don’t pay them off each month. Normally, sound financial advice would tell you to do just the opposite, and that is true for managing your finances and keeping spending under control. You’re not doing that. You are rebuilding your credit. Remember, these companies are gambling on you because they get to charge you more interest rates. So, give them their interest rates.
Let them Profit Off You, But Just for a While
Give them their profit. How? By going in a spend-and-pay cycle. Pay your credit cards off in full every two months. One month of interest charges to carry over, and the next month back down to a zero balance. This is the dirty secret of how you rebuild credit. Paying it off in full every month doesn’t help Providian or whoever took a chance on you. Give them their reward, and you’ll see your credit limit start increasing. And naturally, you will keep your spending in control. Use your new credit card not because you have to, but because you want to. It’s merely a credit-rebuilding tool, nothing more.
You’ve seen how companies are in the business of making money, and you can help them make money and benefit personally at the same time. You can establish and rebuild your credit after bankruptcy discharge. There is a way to spend and pay with the new credit card that helps them and helps you. Most importantly, it should be obvious by now that there is credit after bankruptcy. While bankruptcy is not for everyone, it may give you the fresh start you need. Fear of not having credit in the years ahead should not be a reason that stops you from doing what will help you and your family get the peace of mind you deserve.