Each year, more than 700,000 people in the U.S. file for bankruptcy. Their reasons vary. Some might overspend on credit cards. Others face insurmountable debt due to job loss, divorce or unavoidable medical expenses.
If you’re thinking of declaring bankruptcy or just went through the process, you may already know it will damage your credit, possibly lowering your credit score by hundreds of points, and will stay on your credit report for seven to 10 years.
The good news is that you can rebuild your credit, even while the bankruptcy is on your credit record.
First, it’s important to understand exactly how bankruptcy will impact your credit report and your ability to get a loan. In some ways, that depends on the type of bankruptcy you file.
There are two main bankruptcy chapters available to individuals:
Chapter 7 involves liquidating your assets, using the proceeds to pay creditors and eliminating your remaining eligible debts. It essentially allows you to make a fresh start by releasing you from all of your dischargeable debts. Chapter 7 is typically only available to people who have no hope of repaying their debts.
Chapter 13 is a better option for individuals whose problems stem from creditor demands for immediate payment rather than a lack of income. This form of bankruptcy allows the person to keep their assets while working on a court-approved repayment plan. Upon completion, any remaining eligible debts are discharged.
A Chapter 7 bankruptcy filing remains on your credit report for up to 10 years, while a Chapter 13 bankruptcy filing stays on your credit report for up to seven years.
But how much it affects your credit score depends on your entire credit profile. For instance, someone with good credit may see a drop of 100 points or more, while someone who already has several negative items on their report may see only a modest decline. (Learn how to read your credit report here.)
No matter which chapter applies, bankruptcy is considered negative information on your credit report and will impact how future creditors view you. They may deny credit applications, offer you higher interest rates or require larger deposits.
The good news is the impact of that negative information will lessen over time, especially if you work to rebuild your credit.
There’s no quick fix for rebuilding credit after bankruptcy, but here are three key ways to get back on track.
Saving money won’t directly impact your credit report, but it’s an essential first step toward rebuilding after bankruptcy. Having a cash cushion helps you avoid relying on credit cards when unexpected expenses arise and can help ensure you can pay your bills in full and on time every month. See more about emergency savings accounts.
"Especially in the first year after bankruptcy, you may have trouble getting a regular credit card," says Beverly Harzog, a consumer finance analyst and credit card expert at US News and World Report.
Harzog recommends applying for a secured credit card. With a secured card, you provide the bank or credit card company a deposit. The lender keeps your deposit as collateral and gives you a credit limit equal to that deposit. If you don’t pay your bill on time, the lender can take your deposit and apply it to the debt.
"A secured card gives you a chance to get back in the game on a very limited basis," Harzog says, "although even secured cards may deny you due to a bankruptcy." She recommends going to your bank where you have a checking account and talking to the manager to ask how long you should wait before applying.
Harzog says some of the larger banks want you to be at least a year removed from the bankruptcy. "But I’ve seen some exceptions. If you are approved, they might charge a really high interest rate, but you shouldn’t be carrying a balance anyway,” Harzog said.
For some people, credit cards are too much temptation to overspend. In that case, a credit builder account might be a better option. Similar to a secured credit card, a credit builder loan collects a deposit and gives you a line of credit equal to your deposit. That deposit goes into a savings account that you cannot access until the loan is paid in full. As long as you pay as agreed, the lender will send a favorable report to the credit union.
“If you don’t want to use credit cards again, a credit builder loan is a safe way to go,” Harzog says.
Paying your bills on time is one of the most important steps you can take to rebuild your credit after bankruptcy. And that includes bills that don’t typically get reported to the credit bureaus, such as utilities. Payment history is about 35% of your credit score.
"It’s all important," Harzog says. “Sometimes people don’t have the money to cover all of their bills, so they’ll pay their credit cards but not their utility bills thinking the utilities won’t be reported to the credit bureaus. But if an unpaid utility bill is reported to a collection agency, it will affect your credit.”
Rebuilding your credit takes time, but you won’t have to wait seven to 10 years to buy a home or get a car loan. If you take steps to rebuild your finances and handle credit responsibly, you may be eligible for a mortgage in as little as one year after a Chapter 13 bankruptcy or two years after a Chapter 7.
You can typically get approved for a car loan just a few months after your bankruptcy is discharged, but be aware that bad credit auto loans usually have high interest rates.
After the bankruptcy, Harzog recommends getting a free copy of your credit report from annualcreditreport.com and reviewing it to make sure the bankruptcy and debt discharge were reported accurately.
Assuming everything on your report is accurate, and you’re within the seven- to ten-year reporting period, there is nothing you can legally do to have the bankruptcy removed from your report.
“By law, if something on your credit report is accurate, you can’t have it removed,” Harzog says. “The system is set up to give lenders an accurate picture of your credit history.”
That said, Harzog says some companies provide a service researching and disputing errors on your credit report. “But you can do that on your own,” Herzog says. “If you don’t have time to do it on your own but have the money, you might give it a try, but you can do it on your own.”
Before you hire anybody to help improve your credit score, be sure to do your research and check out the company’s rating with the Better Business Bureau. “There are some legitimate companies,” Harzog says, “but if they ‘guarantee’ anything, run. Nobody can guarantee anything when it comes to your credit.”
Janet Berry-Johnson is a Certified Public Accountant and personal finance writer. Her work has appeared in numerous publications, including CreditKarma and Forbes.