Your credit score plays a very important role in many financial transactions in your life. Your credit score not only dictates whether you can borrow money and what interest rate you’ll be charged, but it can also impact your auto insurance score and can even be checked by potential employers and landlords. As such, having a good credit score is important to show you are responsible and that you have your finances under control.
Unfortunately, bankruptcy is one of the worst things that can possibly happen to your credit score. When you file for bankruptcy, the bankruptcy judgment is going to show up on your credit report for between seven and ten years after the bankruptcy has been completed. During this time, you may appear to lenders to be a very risky investment and you may find many lenders unwilling to work with you and even landlords unwilling to rent to you.
Bankruptcy, however, does not mean the end of your financial life and it doesn’t mean that you’ll never have good credit again. In fact, you can start rebuilding your credit as soon as your bankruptcy is over and within just a few years, you may even be able to earn a better credit score than you had before the bankruptcy when you were struggling with your debts.
How to Rebuild Credit After Bankruptcy
The best way to rebuild your credit after bankruptcy is to develop an understanding of what factors impact your credit score. There are five major considerations used by the credit bureaus to determine your credit score and your creditworthiness. These include:
- Your payment history. Do you pay on time? The later you are on making a payment, the bigger the hit to your score. Judgments against you are also factored in when determining your payment history, so your bankruptcy is going to hurt you here.
- Your credit utilization. Creditors look at the percentage of your available credit you are using. For example, if you have $1000 of credit available and you’ve charged up $500, then you have a 50 percent utilization rate. Typically, you should try to keep this rate at around 30 percent or less since maxing out your cards or charging too much sends up red flags to lenders that you are about to get into debt trouble.
- The average age of your credit cards. The older the cards you have and the longer your history of successful payments, the higher your score will be.
- The mix of different types of credit you have. Lenders like to see that you have different kinds of debt and have been responsible with all of them. For example, having a mortgage, a car loan and a credit card is better than having three credit cards.
- The number of inquiries on your credit report. An inquiry is put on your report each time you apply for credit and stays there for two years. Too many inquiries sends up red flags to creditors and lenders because it suggests you’re starting to take on a lot of debt and might be priming for a spending spree.
Once you understand these different factors and how creditors look at them, you can take some steps to improve your post-bankruptcy credit score.
Steps to Rebuilding Credit
In order to rebuild your credit, you are going to need to work on improving the payment history record you have. This means that you’ll need to get credit. It can be hard to do this after a bankruptcy, so you should apply for a secured credit card (one where you set aside cash in a special account that is equal to the credit limit and that the lender can seize if you fail to pay). Once you have a secured card, you should use it to make small purchases and then pay it off on time every month. Remember, you don’t need to carry a balance (and don’t want to carry a high balance or you’ll hurt your utilization score).
After you’ve been using your secured card for a while and have established that you are now a responsible borrower, you may wish to apply for one more small loan or for a different type of credit such as a mortgage or a car loan. You don’t want to apply for too many loans or for too much credit as you’ll lower your average age of accounts and get too many inquiries, both of which will hurt your score. However, having a mix of different types of credits beyond just a secured card is only going to help you to improve your score.
Ultimately, if you have a few different kinds of loans on your record, all of which are paid off on time, and you aren’t using too much of your available credit, you’ll begin rebuilding credit for you FICO and other credit scores. In time, the bankruptcy will fade into the difference and take on less and less importance as the credit bureaus and lenders focus on how responsible you are being with your money and debt