As you no doubt know, your credit score is important if you want or need to borrow money or make a credit purchase. Although some people understandably are wary about using credit after the traumatic experience of incurring too much debt and filing bankruptcy, it's still usually helpful in life to have decent credit. Even if you are not on a mission to improve your credit as quickly as possible, good credit is worth having in case you need it.
The purpose of a credit report and a credit score is to tell your potential creditor how risky lending to you would be. People with better credit are a lower risk and so are more likely to get approved for new credit, and will get better terms—lower interest rate and maybe lower monthly payments. Those with poorer credit are a higher risk and so are less likely to get approved, or if they are approved the interest and payments terms are likely to not be as good.
WHAT ARE THE REAL WAYS TO IMPROVE YOUR CREDIT?
In my last blog post, I referred to the following three steps:
1. Review and correct credit report errors.
2. Avoid ongoing and future negative credit events.
3. Build positive credit.
That blog post covered the first of these three steps; today I cover the other two.
WHAT ARE THE NEGATIVE CREDIT EVENTS I CAN CONTROL?
This may seem obvious, but the most immediate way to start rebuilding your credit after bankruptcy is to consistently make your payments on any of your remaining debts, and always on time. Pay more than the minimum payments when possible to demonstrate your capacity to handle more credit, as well as to lower your balance(s) faster for the same purpose. This applies to reaffirmed debts under Chapter 7 "straight bankruptcy" and secured debts being paid outside a Chapter 13 "adjustment of debts" plan. It also applies to ongoing expenses such as utilities and housing rent.
To be honest, doing all this may take a significant mental shift. You are likely transitioning away from a financially very difficult pre-bankruptcy life in which you simply did not have enough money to pay any or most of your debts, one in which you didn't have the luxury of thinking much about your credit. In your new life after bankruptcy, you will probably only have one or two remaining creditors, and you need to shift into a mode of paying them perfectly. You will need to figure out for yourself how to be effectively disciplined about doing this, about making this transition to a life in which you have more control over your credit.
This transition begins right away, during the month after filing your bankruptcy case. If you file a Chapter 7 case and are keeping a vehicle or home, assuming this is consistent with your attorney's advice to you, start making the next payments on time and keep doing so. And if you file a Chapter 13 case and are paying any of your secured creditors (such as a vehicle or home) "outside the plan," be sure you do so on time from the start. Also religiously pay your Chapter 13 plan payment on time. Whether or not that will be directly reflected in your credit score, it's important to establish this new discipline right away. The sooner that you begin avoiding negative credit events like late payments, the sooner you will start rebuilding your credit.
HOW DO I BUILD POSITIVE CREDIT AFTER BANKRUPTCY?
If you have any ongoing debts that are surviving your bankruptcy case, pay them diligently as discussed above. But if you discharged (wrote-off) all your debts in bankruptcy, you will need to get new credit in order to build up your credit score.
SHOULD I REALLY GET NEW CREDIT?
You do have to ask yourself if you are ready for new credit. Start by being clear what its purpose is. You are seeking to improve your credit score so that you can access credit and do so less expensively in the future. Part of that is so that you and your family would be better able to deal with future financial emergencies (like car repairs, urgent medical care). Having credit does give you some measure of increased security of this sort.
But you also have to be very clear about what caused your previous credit problems and act proactively to avoid putting yourself again in that situation.
Once you decide to apply for credit, be aware that once you already have one or more credit card applying for another one can hurt instead of help your credit score. That's because about 10% of your credit score is based on new credit or new credit inquiries. Under some circumstances new credit inquiries can look like you are desperate for more credit, so be selective when you do apply for new credit. Be aware that most credit reporting agencies do not keep reporting credit applications after one or two years, and in any event these do not affect your credit score much, but it is something to keep in mind.
A similar percentage of your credit score is based on the length of your credit history. So, new credit accounts bring down the average length, again something to keep in mind, especially if you already have some credit history.
WHAT ARE THE SPECIFIC STEPS FOR BUILDING POSITIVE CREDIT AFTER BANKRUPTCY?
Once you are ready to re-enter the credit world, here are some ways to work your way back in.
#1: GET A DEPARTMENT STORE OR GAS CREDIT CARD
It may be easier to get a credit card from a department store or gasoline company than a regular credit card. These companies usually open your account with a very low credit line. If you deal with the account appropriately, this can open the door to a regular (Visa/MasterCard/Discover) credit card.
When you use your department store or gasoline card, pay off the entire balance every month because:
- The interest rate on these cards can be quite high.
- Because the credit limits tend to be on the low side, even if you carry a relatively small balance, the percentage of the credit limit you are using will be high. That hurts your credit score.
- Carrying a balance on these kinds of cards indicates to potential creditors that you are not ready to handle larger amounts of credit.
#2: GET A REGULAR CREDIT CARD
After appropriately using a store or gas card for a year or so, apply for a regular credit card from your credit union or bank. You may only qualify for one with a low balance or high interest rate. After a year or so of using the card and making the payments perfectly, apply for a higher credit limit and/or lower interest rate.
Sometimes you will get regular credit card offers soon after your bankruptcy case is finished, without first going through the store/gas card process. Review the terms very carefully before applying, but such offers can be legitimate—after all you may well be a relatively good credit risk after ridding yourself of most or all of your debt. This may be a sensible way to get a start on rebuilding your credit.
#3: IF YOU CAN'T GET A REGULAR CREDIT CARD CONSIDER A SECURED ONE
With a secured credit card you deposit a certain amount of your own money at the issuing credit union or bank and receive a credit card with a credit limit for a percentage of that deposited amount. How much you are required to deposit can vary from a few hundred to a few thousand dollars. And the credit limit can vary from as low as 50% to as high as 120% of the amount deposited. Because of these differences, and often big variations in costs, it is worth looking at different credit cards.
Besides having to come up with the money to deposit, secured credit cards do tend to be a quite expensive form of credit. Banks often charge big application fees, plus an annual fee, and a relatively high rate of interest, while your deposited money tends to earn only a negligible rate of interest. Plus there's often no grace period—the interest on charges can start accruing immediately instead of after the usual 21 days after purchase. Credit union fees tend to be lower, so that should be your first place to look.
Maybe the most important potential disadvantage with some secured credit cards is that they may not serve the main purpose I'm discussing here—some don't help your credit. First, your future potential creditors may not accept your credit history with a secured credit card as having much weight. Second, some secured credit card lenders may not report your positive payment history to the major credit reporting agencies. Third, some report to them but indicate that it is a secured credit card, thus taking away some of the benefit of your positive payment history. So find out if your prospective secured credit card lender does report to the major credit reporting agencies, and what their reports say about the nature of the account.
#4: IF NEED BE, GET A COSIGNER OR GUARANTOR
If you can't get credit in ways discussed above, the next option is asking a friend or relative to cosign or be a guarantor on a debt.
A cosigner, generally used with consumer credit, signs the loan with you so that he or she is on the hook with you on the debt. A guarantor, more often used with business credit, promises to pay if you don't. Be sure that you find out how your prospective creditor reports the payments you will be making, to ensure that this history will be showing up on and improving your credit history (not just your cosigner's/guarantor's).
#5: GET A CD OR SAVINGS ACCOUNT SECURED BANK LOAN
This is somewhat similar to a secured credit card. You open a certificate of deposit (CD) or savings account at your bank or credit union. Then you ask the lender to give you a loan against the money in your account. As part of the deal, you have no access to the money in your CD/savings account, so the lender has no risk if you don't make the payments. Your history of on-time payments helps rebuild your credit. As with secured credit cards, before you enter into such a secured loan, find out from the prospective lender how they would report your good payment history (to which credit reporting agencies, whether the self-secured nature of the account is revealed) to determine how much this kind of account would help your credit standing.
#6: BUY ON CREDIT FROM A LOCAL RETAILER
Especially if you have lived in one area for some time and been a loyal customer at a local retailer (such as a furniture store), ask if you can buy an item on item on credit. Be prepared to put down 20-30% to reduce the retailer's risk, and likely to pay a high rate of interest. But these may be worthwhile in return for a way to begin rebuilding your credit.
You may even need to first make a layaway purchase, in which you make payments but do not get the item until you have paid the entire purchase price. These are not reported to credit reporting agencies, but after you make the layaway payments on time that may convince the store to give you a store credit card or some store credit.
Again, before getting credit at a local store ask whether they report payment histories to credit reporting agencies, and especially if they report to the major national ones. Finally, even if they don't, it may still be worth getting an account and then keeping a record of your payments to show future creditors your trustworthiness.