Your credit score is a valuable number that impacts your financing opportunities and the amount of money you spend in your lifetime. Late payments and a high credit utilization ratio will bring down your score. Still, bankruptcy can singlehandedly take your score down by over 100 points, depending on what your score was before the bankruptcy.
While you can’t recover from bankruptcy, you should get started as soon as possible. Generating any type of progress in the early stages will give you momentum. It may take 18-24 months to have good credit again, but it starts with your actions. We will share how the bankruptcy process works and affects your credit score. We will then share some ways to rebuild your credit sooner so you can get better loans and other perks in the future.
The Bankruptcy Process
It’s best to take every possible precaution to avoid bankruptcy. This is the last resort if you do not have another way to pay your financial obligations. Bankruptcy can reduce your debt burden or eliminate it entirely, depending on the court ruling. You won’t have to pay any loans during the bankruptcy process. To start fresh, you may have to liquidate your assets, including your home. Other people filing for bankruptcy may get more flexibility to repay their debts rather than get them eliminated entirely. Bankrupt individuals who follow the latter path won’t have to sell off their assets to repay their financial obligations.
What Happens to Your Credit Score After Bankruptcy?
Your credit score will plummet upon declaring bankruptcy. It can drop by over 100 points depending on what score you had beforehand. This event wipes out a lot of points from your credit score and stays on your credit report for up to 10 years, depending on the type of bankruptcy. Bankruptcy is the worst-case scenario and can hurt your chances of qualifying for loans or credit cards in the future.
How Long It Takes to Build Your Credit After Bankruptcy
You’re looking at over a year for the credit rebuild process, regardless of which type of bankruptcy you incur. However, a Chapter 7 bankruptcy is worse than a Chapter 13 bankruptcy.
A Chapter 7 bankruptcy occurs when you liquidate your assets and start with a clean slate. Unfortunately, your credit score won’t be as lucky. Not only will it plunge upon bankruptcy, but it can take 18-24 months to recover from this bankruptcy. A Chapter 7 bankruptcy stays on your credit report for 10 years. The credit bureaus will automatically remove the bankruptcy from your credit report once the 10 years are up.
A Chapter 13 bankruptcy is less devastating than a Chapter 7 bankruptcy, but you don’t get out of the debt entirely. Debt gets restructured, and you will have to repay it within 3-5 years. You will either owe the full amount or a partial amount, depending on what the bankruptcy court decides. A Chapter 13 bankruptcy stays on your credit report for 7 years, and it takes 12-18 months to recover. You don’t have to liquidate your assets, but that can change if you fall behind on the reorganized debt payments. Therefore, it’s critical that you keep up with payments if you get your debt renegotiated through a Chapter 13 bankruptcy.
Rebuilding Credit After Bankruptcy
Consumers have several ways to repair credit after bankruptcy. Applying these strategies will help you look at a 12-18 month recovery window instead of an 18-24 month recovery window.
Review Your Credit Reports
Your credit reports won’t look pretty after bankruptcy, but you may find some errors. Credit bureaus make mistakes, and your financial obligations can change quickly after filing for bankruptcy. So make sure each item on your credit report is accurate and dispute any errors that show up.
Practice Good Financial Habits
Money habits play a big role in each consumer’s financial outlook. While many bankruptcies are the accumulation of bad financial habits, some of them emerge because of medical bills. A set of good financial habits will get you on the right track regardless of how you arrived at this destination.
Good financial habits revolve around growing your money and minimizing your spending. After a Chapter 7 bankruptcy, you won’t have any debt, so it’s important only to incur debt you can pay off. Getting debt right away may not be a good idea since you will have to contend with higher interest rates. We will share some debt instruments to apply for during this process, but if you do get into debt, prioritize paying it off.
Living below your means, building an emergency fund, and investing your remaining funds will put you in a good position. You can use certificates of deposit (CDs) to grow your emergency funds if you don’t need them right away. You should track your income and expenses to become more alert about each purchase and trim your costs.
Don’t Overutilize Your Credit
Credit can help you out of jams and make it easier to buy goods and services. However, you shouldn’t lean too much into it. Your credit utilization influences 30% of your credit score. A higher credit utilization ratio will reduce your score, but if you keep it below 30%, you can improve your score. For example, if you have a $1,000 credit limit, you should not borrow more than $300 against your credit to stay below 30%.
It is optimal to get your credit utilization below 10% for the maximum credit rebuild. You can reach that level by requesting a higher credit limit or paying more of your debt. If you just filed for bankruptcy, it will be difficult to raise your credit limit, but you have more control over your ability to repay debts. You can pick up a side hustle or explore another income stream to make debt repayment easier.
Apply for a Secured Credit Card
Imagine if every purchase you make from here on out puts your credit in a better position. Credit cards make this possible as long as you repay every bill before the due date, but most credit card issuers will reject your application if you just wrapped up a bankruptcy.
Luckily, you can still get a secured credit card. These starter cards require a refundable security deposit, usually $200 or more. The refundable security deposit becomes your credit limit, and the tighter credit line can force you to develop better financial habits. In addition, payment activity on these cards gets reported to the major credit bureaus, just like a traditional credit card. Some credit card issuers let you upgrade your secured credit card for an unsecured card within a year, but it may take longer if you are recovering from bankruptcy.
Just don’t apply for too many at the same time because those hard credit inquiries will add up and hurt your score. Instead, if possible, seek a secured credit card that conducts a soft pull during the preapproval process. Then, you know you will likely get approved for the secured card before submitting your application.
Become an Authorized User
An authorized user benefits from someone else’s credit card activity. You can become an authorized user of a family member, relative, or friend who pays bills on time. You don’t have to do any additional work to have their good money habits rub off on your credit score. However, your credit score will take a hit if the primary cardholder falls behind on their debts. You should only become an authorized user for someone you trust to be financially responsible.
Get a Credit Builder Loan
A credit builder loan lets you rack up a series of small wins for your credit score. These loans have small amounts ranging from $500 to $1,000. Loan terms are also short, as you will have difficulty finding a credit builder with more than a 2-year term. Credit builder loans aren’t traditional financial products. Lenders only give you the loan proceeds after you make all of the monthly payments. The lender reports each monthly payment to the major credit bureaus, allowing you to accumulate payment history.
It wouldn’t make sense for someone with good credit to take out a credit builder loan. However, it makes more sense for credit invisibles and people who want to repair their credit scores. A 24-month term reduces your monthly payments, which can make it easier to navigate the loan alongside your other expenses.
Regularly Monitor Your Credit
If you want to rebuild your credit, you should stay focused on it. Monitoring your credit score lets you see progress and receive alerts that can help you improve your score. You can analyze what is working and not working for your credit rebuild. Most banks let you look at your FICO score for free in your dashboard. You don’t have to request a credit report to know your score.
This is perhaps the hardest part about rebuilding your credit score after bankruptcy. Paying on time, reinforcing good money habits, and doing all of the right things will not put you back to a good credit score on the first day, week, month, or even year. It takes time to recover from bankruptcy, but it is possible. Envision breaking out of debt and having a good credit score. It will help you push through each day on the journey to rebuilding your credit.
Is It Possible to Get an Even Better Credit Score After Bankruptcy?
It will take a while to reach your pre-bankruptcy credit score, but it’s possible to fully recover in a few years and even surpass your pre-bankruptcy credit score. Of course, it will take considerable work and a long-term mentality to achieve that goal, but it’s possible with the right resources and mindset.