Steps to rebuild credit after bankruptcy
Obtain secured credit, become authorized user, borrow small, dilute the bad news
By Barry Paperno | Published: November 6, 2014
Speaking of Credit
Dear Speaking of Credit,
I just filed for Chapter 7 bankruptcy. My current car loan is requiring me to sign a reaffirmation for the car. What do I do about that? What are the disadvantages of signing those documents? Will it help build up my credit? Also, I don't have any credit cards open at this point since they were all in collections. How do I go about getting back credit and reapplying for credit cards? Please advise. -- Adenike
Sorry to hear about your bankruptcy, though, if it helps any, you're not alone. In the first three quarters of 2014, more than 900,000 consumers filed for bankruptcy, often due to circumstances beyond their control, such as medical expenses and job loss. Fortunately, within this hardship you now have the opportunity to wipe the slate clean and essentially start your credit life over.
If there's a plus side to bankruptcy, it's that taking this step can be better for your credit score than allowing debts to go unresolved indefinitely. It affords you some piece of mind when collection calls and letters stop, and after you file and your score bottoms out there's truly nowhere to go but up. And up it will go, as long as you rebuild your credit sensibly.
To give you just one example of how your score can improve after bankruptcy, the filing date appearing on your credit report becomes the date from which the "recency" of the bankruptcy is measured by the credit scoring formula, both for individual accounts included in bankruptcy and the public record notation of the bankruptcy filing. This is important because the recency of any negative item, such as bankruptcy, is one of the most heavily weighted factors within the most heavily weighted category of scoring -- payment history -- amounting to 35 percent of your score. The longer the time since the bankruptcy, the less negative impact it will have, and the higher your score will go.
A good place to begin discussing the rebuilding of your credit is with the length of time bankruptcy-related information stays on your credit report. Generally, most negative information remains on a credit report for about seven years, with Chapter 7 bankruptcy public record items being among the most notable exceptions. Some examples of how long you can expect to see bankruptcy-related items on your credit report are:
- Chapter 7 bankruptcy public record items: 10 years from the filing date.
- Completed Chapter 13 bankruptcy public record items: seven years from the filing date.
- Cards and loans included in bankruptcy: seven years from the filing date, whether Chapter 7 or 13.
- Collections discharged in bankruptcy: 7.5 years from the date the debt first became delinquent, whether Chapter 7 or 13.
Reaffirmation and your credit score
In addition to inquiring about the best ways of obtaining new credit cards, your questions about reaffirming the auto loan are particularly good ones, as even bankruptcy attorneys often don't know such credit scoring specifics.
When reaffirming your auto loan, the bankruptcy court is allowing you to exclude this debt from the bankruptcy, meaning you can keep the car and continue to pay under the original or newly negotiated terms. Reaffirming may result in the notation "Reaffirmation of Debt" added to the auto loan on your credit report. But you should be pleased to know it will have no negative impact on your credit score.
As to whether reaffirming will help build your credit, you'll also be happy to know that it will, as long as the loan remains in good standing. However, there could be some noncredit disadvantages to reaffirming, so I'm going to strongly recommend consulting with your bankruptcy attorney before agreeing to the reaffirmation.
You can proactively accelerate the rebuilding process by, in essence, diluting the negative credit on your credit report with the addition of new positive (paid on time) accounts.
Another important piece of the credit score rebuilding puzzle to know is that you can proactively accelerate the rebuilding process by, in essence, diluting the negative credit on your credit report with the addition of new positive (paid on time) accounts. This process taps into the credit scoring calculations that evaluate the proportion of positive and negative accounts within the total credit picture.
3 credit rebuilding tools
Three good tools for building positive credit history are:
- Secured credit cards.
- Secured personal installment loans.
- Unsecured credit cards where you have been added as an authorized user.
Secured credit cards and secured personal installment loans are made available to low-scoring consumers for the purpose of credit rebuilding, and are backed by a savings account used as collateral to protect the lender in case of default. Both secured products are typically reported to the credit bureaus each month, but you'll want to double check before applying. Both are also treated just like the unsecured variety by the credit scoring formula. For secured cards, it's best for your score and pocketbook to make small purchases and pay in full each month to keep the card active while avoiding finance charges. For both secured and unsecured cards, there is no scoring benefit to carrying a balance from month to month.
For secured personal loans, use the proceeds while making the payments on time each month. Unfortunately, since it's best for your score to keep these loans open for as long as possible, you'll be paying interest, which makes secured personal loans the most expensive option. Still, the costs may be offset by the possibility of adding points to your score by demonstrating you can handle a mix of credit types -- revolving (cards) and installment (fixed-payment loans).
With authorized user cards, when you're added to an account in this way, you are typically not held responsible for the debt and there are no credit requirements. Yet the entire account history appears on your credit report and contributes positively to your credit score -- assuming, of course, the primary cardholder's account is in good standing. One rather odd feature of this score-building tool, but one that that can enable the cardholder to feel less at risk, is that the authorized user doesn't have to use or even possess a card to reap the benefits -- again, assuming the account remains in good standing.
Hope this helps. Good luck in your new credit life after bankruptcy!
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