Being formally excused from paying what you owe with a Chapter 7 bankruptcy may be an emotional and financial relief, but it’s also the worst thing you can do to your credit rating. Few banks and credit issuers will even consider lending you money again, and those that do will only offer the worst possible terms.
Well, yes and no. Filing for bankruptcy is a clear indication that you did not pay your bills, and to a lender, that tends to be perceived poorly. After all, if you didn’t fulfill your end of the contractual bargain before, whose to say you will now? For that reason you’ll be pegged as a risky customer.
In fact, because lenders consider payment history so important, it is the weightiest factor in most credit scores, including the two biggies: FICO and VantageScore. Therefore the bankruptcy notation will cause your scores to nosedive (unless they’re already on the floor, that is). FICOs and VantageScore begin at 300 and go up to 850. By the time you file, your numbers may already be at the bottom of the scale. Late payments, defaults and collection action will do that.
Yet while lenders will assess your credit history and credit scores to determine eligibility, they also assess other factors about you. The amount of debt you currently hold is crucial. The less you owe the better, and the beauty of Chapter 7 bankruptcy is that you can walk away from all dischargeable obligations. After that, no longer is a portion of your earnings promised to other creditors, so your borrowing capability opens up. For this reason, the credit utilization portion of a credit score can get a major boost when your debts are wiped out via bankruptcy.
And then there’s income. Whether you want a mortgage, vehicle or personal loan, or a credit card, a secure source of income will be required. All lenders want to make sure that you have the means to repay, and the more money you make, the better. When high income is coupled with no or low debt, you can overcome a ruined credit rating. Remember, lenders just want to be assured that you can and will make your payments.
So here is what you should do to qualify for a great loan or credit card after the bankruptcy is over.
1. Check your credit score. You need to know where you stand so you can work your way up with specific actions. Excellent scores are in the mid 700s and up. If you want loans and credit lines with low interest rates and feel, reaching that mark should be your goal.
2. Secure or increase your income. Remember, money talks. If you have a considerable amount coming in, you’ll be a more compelling applicant. Do what you can to maximize your earnings and stabilize your job.
3. Make good on remaining balances. Since not all bills are dischargeable in bankruptcy, you may have such liabilities as students loans, legal fees, and back taxes to take care of. If so, get back on track with them. The sooner you have twelve months’ worth of on-time payments on your credit report, the faster your credit scores will recover. As the balances decline your credit utilization ratio will also expand and result in higher scores.
4. Get a secured credit card. Many credit card issuers are willing to extend a line of credit that is collateralized by cash. The credit line may be very small to begin with, but that’s fine. You’ll be using it for a specific purpose and that’s to show new lenders that you can borrow and repay money according to the agreement. So if your credit limit is $500, charge your monthly health club dues of $65 each month (or some other nominal expenditure). Have that entire sum automatically deducted from your checking account and applied to the credit card so it gets in before the due date and you never accumulate a running balance. After a year, your credit scores will be far higher than they are today.
5. Consider a cosigner or being an authorized user. Another way in to the credit rating recreation party is to have someone with a positive credit rating cosign on a loan or credit card for you. The lender will have the assurance that if you don’t pay, the other person will. Or see if someone will add you to their credit card as an authorized user. You’ll be an honored guest on the account and that card will show up on your credit reports. If the owner manages the card well, your scores will rise.
6. Don’t apply all over town. Hard credit inquiries will show up on your credit reports. They are a relatively minor credit scoring factor, but if you don’t have much on your credit reports they will play a far greater role. Apply prudently, and only for those accounts you are likely to get. Many applications in a short period of time are an indication of financial desperation —which will make lenders worried about your circumstances.
7. Wait it out. Chapter 7 bankruptcies remain on credit reports for ten years from the filing date, but after two years the effect on your credit scores will start to wane – especially if you steadily add attractive data to your reports. Give yourself the opportunity to recover. As the bankruptcy notation ages, your financial circumstances improve, and credit rating escalates, products with attractive terms will be within reach. Then when the bankruptcy is no longer listed, no one will be the wiser – and you’ll fully rebound.
If you follow this plan, I assure you that just about any lender will be honored to do business with you.