Understanding Bankruptcy and Rebuilding Your Credit

Bankruptcy can be a necessary step for individuals overwhelmed by debt, but it can also wreak havoc on your credit scores. The impact of bankruptcy on your credit can last up to 10 years, though its negative effects will lessen over time. Here’s what you need to know about how bankruptcy affects your credit, how to rebuild your credit history, and how long the process can take.

What Happens to Your Credit When You File for Bankruptcy?

Filing for bankruptcy will significantly impact your credit score, though the extent of the impact varies from person to person. Your unique credit profile, composed of several variables, will determine the specific effects. Additionally, the type of bankruptcy—Chapter 7 or Chapter 13—will influence your credit differently.

Here’s what you can expect:

Your credit score will decrease: Filing for bankruptcy indicates that you can no longer pay your debts as originally agreed. Since your payment history is the most influential factor in your FICO® Score, you can expect to see a drop in your credit score. The amount of the decrease will depend on your credit score before filing, the events leading up to the bankruptcy, and your overall credit history.

You’ll have trouble qualifying for credit: If you have an open bankruptcy, you generally can’t apply for any new credit. Even after your bankruptcy has been discharged, your options will be limited.

The bankruptcy will stay on your reports for years: Chapter 13 bankruptcy, which involves restructuring your debt with a new repayment plan of three to five years, will remain on your credit reports for seven years from your filing date. In contrast, Chapter 7 bankruptcy will stay on your reports for 10 years because you’re liquidating assets to pay off a smaller portion of your debt.

How to Build Back Your Credit After Bankruptcy

Rebuilding your credit after bankruptcy can seem daunting, especially considering that the bankruptcy record will stay on your credit reports for up to 10 years. However, the negative impact of bankruptcy can diminish over time, especially as you practice good credit habits and add positive information to your credit file. Once your bankruptcy has been discharged, here are some steps you can take to help your credit history recover.

Review Your Credit Reports

Start by ensuring that your bankruptcy is correctly reflected in your credit reports. Then, review the rest of the information in your credit reports to identify other areas you can address, including inaccurate information, which you have the right to dispute with the credit bureaus. You can access your Experian credit report anytime for free, and you can also review your TransUnion and Equifax reports for free at AnnualCreditReport.com.

Always Pay on Time

If you still have open and active accounts that were not included in bankruptcy, making every payment on time moving forward is key to rebuilding your credit. The same goes for any new credit accounts you open.

Open a New Credit Account

It can be difficult to qualify for new credit after bankruptcy, but there are some options available:

Secured credit card: A secured credit card functions similarly to a traditional credit card but is designed for people with less-than-stellar credit scores. To get approved, you’ll need to make a refundable security deposit, typically equal to your desired credit limit. As you use the card responsibly, the positive information can help increase your credit score. If you pay your balance in full each month, you can even avoid interest charges.

Credit-builder loan: Credit-builder loans are installment loans that provide you with the loan funds after you’ve finished making payments instead of upfront. Repayment terms may range from six to 24 months, and because the lender is holding on to the loan funds until it receives full payment, credit-builder loans typically have reasonable interest rates.

If you can’t get approved for credit on your own yet, consider asking a loved one with good credit habits to add you as an authorized user on their credit card. Once you’re added, the card issuer will report the full account history to the credit bureaus, which can help improve your credit.

Keep Credit Card Balances Low

For new and existing credit cards, plan to keep your balances low relative to your account credit limits. Your credit utilization rate—the percentage of available credit you’re using at a given time—is one of the most important factors in your FICO® Score, so it’s critical to keep it as low as possible. If you have a secured card with a low credit limit, that may mean only using the card for occasional small purchases instead of for everyday expenses.

Sign Up for Experian Boost®

Experian Boost is a free feature that allows you to add monthly payments to your Experian credit file that aren’t normally reported. This includes your cellphone and utility bills, rent payments, insurance premiums, and even some streaming subscriptions. Once you register, link the bank accounts you use to pay bills, and then select which payments you want to add to your Experian credit report. You’ll be able to see the results instantly.

Monitor Your Credit Regularly

As you work to rebuild your credit, Experian’s free credit monitoring service can make it easy to track your progress. You’ll get access to your Experian credit report and FICO® Score powered by Experian data. Additionally, you can get real-time alerts when changes are made to your credit report so you can stay on top of new developments.

How to Avoid Bankruptcy

While bankruptcy may be unavoidable for some, it’s not a decision to take lightly. Before filing for bankruptcy, it’s crucial to explore all other options. Here are some alternatives that could potentially help you avoid bankruptcy:

Evaluate Your Situation

Take inventory of your debt to get a full picture of what you’re dealing with. Creating a budget can also help you get a better idea of where your money is going, making it easier to determine whether you can afford your debt payments as is or on a modified basis. If possible, look for opportunities to increase your income to improve your cash flow.

Consider Other Debt Repayment Strategies

If your evaluation reveals that you have some options to handle your debt on your own, consider repayment strategies like the debt snowball and debt avalanche methods. If your credit is still in good shape, you may even consider consolidating your debt with a balance transfer credit card or consolidation loan.

Consult with a Credit Counselor

A credit counselor working with a nonprofit credit counseling agency can assess your situation and provide free, personalized advice. They may even recommend a debt management plan, which can help reduce the burden of unsecured debt like credit card balances by negotiating a restructured repayment plan with lower payments and interest rates.

Talk to Your Lender

Some lenders may be willing to provide some relief in the form of a lower interest rate or modified monthly payments, especially if they know you’re on the brink of bankruptcy. That’s because they stand to lose less by working with you.

Consider Debt Settlement

Debt settlement involves negotiating with your creditors to accept less than what you owe. This option can negatively impact your credit score, especially if you work with a debt settlement company or law firm that recommends you stop making payments during the negotiation process. However, the credit impact from settling an account may still be less drastic compared to bankruptcy.

After considering these options, consider hiring a bankruptcy attorney to get advice on your situation to determine whether bankruptcy is the best move for you.

The Bottom Line

Bankruptcy can greatly affect your credit score, but if it can set you up for a better financial future overall, it can still be a sound financial decision. Before you pursue bankruptcy, rule out all other alternatives and consult with professionals who can give you much-needed guidance.

As your bankruptcy wraps up, start strategizing about how you want to rebuild your credit. While it can take time to establish a good credit score after bankruptcy, being proactive about the process can help you achieve your goal faster.

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