Although bankruptcy can give you a new start financially, it can also make it difficult to borrow affordably.
That’s why rebuilding credit after bankruptcy is such an important task for borrowers. Otherwise, applying for new credit can seem like an expensive undertaking.
As time goes by, the good credit behaviors you establish will outweigh the negative impact of your bankruptcy. This is because the FICO credit scoring model favors new information over old information. So while the negative item will remain on your credit report for 10 years, you can still build an excellent credit history.
Your bankruptcy does not need to determine your financial future. Here’s how to get your credit back on its feet.
Why bankruptcy matters to lenders
When you file for bankruptcy, it signals to lenders that you cannot manage your credit effectively. From their perspective, they’re afraid they may end up losing some or all the money they lend you.
It’s important to note that not all bankruptcies are due to financial mismanagement. Perhaps you ended up filing for bankruptcy because of medical bills, a divorce, or other reasons outside of your control.
Even if your bankruptcy wasn’t your fault, banks still view you as a risk and may not offer you credit. And if they do offer credit, it’ll likely come with unfavorable terms.
How to start rebuilding credit after bankruptcy
Regardless of how you got to this point, learning how to rebuild credit after bankruptcy can help you get back on the right track sooner than you think.
1. Assess where you stand
Depending on how you were managing your credit before the bankruptcy, it’s possible it didn’t completely destroy your credit.
Start by getting a free copy of your credit reports from AnnualCreditReport.com to see where you stand credit-wise. You should also make sure there aren’t any errors holding your credit down. Dispute any credit report errors you find ASAP.
Next, check your credit score. Depending on your bank, they may offer you a free credit score. If not, several companies offer free access to your credit score. Also, keep in mind that your credit score won’t be dinged if you check it.
As you continue to rebuild credit after bankruptcy, make sure you track your credit score and see that it’s improving.
2. Get on a budget
If you haven’t budgeted up to this point, now is a very good time to start.
At the end of the day, budgeting is all about managing your cash flow. Your budget can be as simple as dividing up your expenses into three categories using the 50/30/20 rule: needs, wants, and financial obligations (e.g. savings and debt payoff).
You can also choose to break down each spending category separately. For example, under the needs category, you can create subcategories for rent, groceries, and utilities. For the wants category, you can include things like cable TV, eating out, and entertainment. With this approach, you can choose as few or as many categories as you want.
Whatever you choose, tailor your budget in a way that prioritizes saving and paying down future debt. Managing your money each month with this in mind can help prevent another situation like the one that caused your bankruptcy.
3. Begin using credit again
Because your bankruptcy will be a red flag for lenders, your options for credit will be few. There are, however, a few different options that may be more accommodating.
Secured credit card: A secured credit card functions the same as a conventional credit card, with just one exception. With a secured credit card, you have to put up a deposit — usually equal to your desired credit limit — when you open the account.
In most cases, you can’t get the deposit back until you close the account. Secured credit cards sometimes carry high interest rates and annual fees, so be sure to keep those in mind while you’re searching.
Credit builder loan: These loans are unique in that they also sometimes require a security deposit upfront. Other lenders may put the amount you borrow in a savings account while you’re paying off the loan then give it to you at the end of the term.
In exchange, the lender reports your payment history to the credit bureaus. Self Lender is a good option for credit builder loans because their interest rate is much lower than what you’d get with a secured credit card. Other lenders include Digital Federal Credit Union, Republic Bank, and City National Bank.
You can also check with a community bank or credit union in your area to see if they offer a credit builder loan.
Co-signed loan or credit card: Lenders may not be willing to give you credit based on your credit history alone. They may reconsider, however, if you can get someone with good history to vouch for you as a co-signer. You can do this with either a loan or a credit card.
However, not all banks allow co-signers on their credit card applications. So make sure you check with the bank before you apply.
Keep in mind that a co-signer is putting their credit on the line by applying with you. A co-signer is equally liable for the debt, and it can harm their credit if you make late payments or default.
Authorized user: If you’re not able to get a co-signer, another option is to ask if you can become an authorized user on a family member’s credit card.
By doing this, you’ll benefit from the primary cardholder’s payment history without actually having to use the card. Unlike with a co-signed credit card, authorized users aren’t legally liable for the debt they incur on a card.
Although authorized user status also doesn’t boost your credit score as much as if you were the primary account holder, it does help.
Bankruptcy doesn’t mean death for your credit
Rebuilding credit after bankruptcy isn’t as hard as it seems. While it may take time and patience to get back into good graces with the credit gods, the path is simple.
The more you establish and practice good credit behaviors, the quicker your credit score will respond. Healthy financial habits will also help you avoid getting into trouble again in the future.
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