When Dave, a homeowner in Iowa fell behind on his debts, he simply stopped paying his mortgage and other debts. Before long, his home was foreclosed. Not only was his credit in shreds, but he also lost his home and all his equity tied up in his home. Unfortunately, Dave never considered bankruptcy — and his credit repair timeline is longer than it should be.
When hard times come and you get over your head in debt, bankruptcy can be a life-saver. Bankruptcy offers a fresh, debt-free start to life, and can preserve some or all of your property and assets — but not without consequences. Bankruptcy will leave you with a poor credit score and will be a prominent mark on your credit report signaling to lenders that they may not be able to count on you to repay your loans in the future.
Fortunately, bankruptcy’s effect on your credit isn’t permanent. Credit scores are built on common sense, and they certainly allow for the possibility that someone with a bankruptcy history can be a stellar borrower going forward. The way credit scores work allow you to rebuild your score over time to good or even excellent credit. We’ll walk through the steps you need to take to build your score back up.
Pay All Bills On Time From Day One
The process of rebuilding your credit begins on the day you file bankruptcy. If you are serious about rebuilding your credit, you need to demonstrate that you are responsible with your finances from day one. Almost anyone you owe money to can report late or missed payments to credit bureaus, so you need to continue paying any and all bills on time. This includes both debt that was left over from your bankruptcy and bills such as your utility, phone and cable bills. The last thing you need at this point is another negative mark on your credit report because a missed bill got sent to a collections agency.
When Will Debts Be Discharged?
The whole point of filing bankruptcy is to have some or all of your debts discharged, or at least re-organized. However, this isn’t immediate. It also depends largely on whether you file chapter 7 or chapter 13 bankruptcy.
Typically after chapter 7 bankruptcy, eligible debts are discharged 4-6 months after initially filing for bankruptcy. During this time, you will need to go through credit counseling, meet with creditors. Additionally, a court-appointed trustee will also handle the selling, seizing or abandoning of your property (with the exception of certain exempt property- your house, one vehicle, retirement accounts, among others).
Chapter 13 bankruptcy, on the other hand, allows you to keep all your property in exchange for completing a period of structured debt repayment. Also, contrary to chapter 7 bankruptcy, chapter 13 bankruptcy includes secured debts such as your mortgage and vehicle loans. Under chapter 13 bankruptcy, debts are not discharged until after you have completed the debt repayment plan, typically 3-5 years.
How to Rebuild Positive Credit
Your payment history is the largest factor in your credit score. However, while keeping negative items such as late and missed payments off your credit report is certainly important to a positive payment history, you also need a record of payments made on time. And while your utility company and landlord may report late or missed payments, they won’t report on-time payments. Only on-time loan and credit card payments get reported to the credit bureaus.
Closely following payment history in your FICO score is your credit utilization ratio (the percentage of debt available to you that you actually use). For example, if your credit card limits add up to $3,000, but your total credit card balance is $1,000, your utilization ratio is 33%. Since a high utilization ratio suggests that you might be struggling financially, keeping a low ratio is important to a good credit score. Ideally, you should keep your ratio below 30%.
Use a Secured Card to Rebuild Credit
This seems like a catch-22. You need access to credit to build your credit score, yet you need a decent credit score to qualify for credit. One of the best solutions is a secured credit card. A secured credit card works like any other credit card but requires an initial security deposit from you. Because the card company can hold the deposit as collateral, they are more willing to offer the card to individuals with low credit. This gives you the chance to demonstrate that you can use credit responsibly by paying your bills on time and only using a small portion of your credit limit.
Once you open a credit card, keep it open, since a longer average account age also helps your credit. Keep this in mind when selecting a secured card. Pick a card you’ll want to stick with, and perhaps opt for a card that can transition to an unsecured account as your credit improves.
Waiting For Negative Marks to Fall Off
After a while, negative marks will fall off your credit report. Other than tax liens, which stay on your report for 15 years, bankruptcies stay on the longest. Chapter 13 bankruptcies come off your report 7 years after you complete your payment plan (between 10 and 12 years after you file). Chapter 7 bankruptcies come off after 10 years. Late payments, missed payments and judgments stay on for 7 years.
Unfortunately, there’s nothing you can do to speed this up. However, as long as you are proactive about building positive credit, you can still significantly increase your score in the meantime. Fresh information in your credit history has much more of an impact than older information, so over time, the effect of your bankruptcy will begin to fade.
Avoid Future Pitfalls By Evaluating Where You Went Wrong
While your bankruptcy is still fresh in your mind, you may find it easy to spend within your means and avoid taking on too much debt. However, as time goes on, you may start slipping into bad habits and picking up more debt. Be careful that you don’t start making the same mistakes that got you into bankruptcy in the first place. Evaluate what led you to bankruptcy and set up systems to prevent a repeat. Consider implementing a budget to keep your spending on track, if that was the issue. Or if a life event caused it, consider safety nets such as insurance and emergency savings. After having experienced firsthand the stress and headache of first drowning in debt and finally going through the bankruptcy process, you likely want to avoid repeating the process at all costs.