How to Rebuild Your Credit After Bankruptcy


Bankruptcy has a profound and negative impact on your credit score, and a bankruptcy discharge will make credit more costly and more difficult to obtain in subsequent years. While rebuilding your credit is a long-term project, with careful effort and financial discipline you can achieve a surprisingly high credit score within even two or three years of bankruptcy.

Demonstrate That You Can Use Credit Responsibly

While bankruptcy may be triggered by many factors, creditors are going to assume that the fundamental reason you declared bankruptcy was because you borrowed more money than you could reasonably repay. As you rebuild your credit, you will want to build a record that shows that you take credit seriously and are not over-extending yourself. You can manage your credit and demonstrate your ability to handle credit and debt by taking some simple steps:

  • Open Savings and Checking Accounts - If you do not already have an open savings and checking account, one of the first steps toward rebuilding your credit is to open those accounts.

  • Make a budget - Keep track of your income and expenses so that you know how much you can afford to borrow and repay in any given month. Make any corrections that are necessary based upon your expenses, so that your budget is as accurate as possible, and then stick to your budget.

  • Build up Some Savings - Your monthly budget should include an amount of money that is designated for a savings account, with the goal of having enough money saved to pay for two or three months of basic expenses in the event of an emergency or job loss.

  • Make Your Payments on Time - Make your payments by the due date. Even if your lender offers a grace period, get yourself into the habit of paying when the payment is due.

  • Be Patient - Due to the high cost of early post-bankruptcy credit and to avoid over-extending yourself, limit your initial borrowing.

Although you will need to apply for credit in order to build your credit history and score, there is no rush. Creditors view a large number of credit inquiries as a negative factor when reviewing applications for credit. If you apply for every credit offer that comes along, you will hurt your credit score and may cause yourself to be denied a loan or credit card that you may have received had you applied for only one.

Borrow Strategically

After a bankruptcy discharge, creditors will deem you to be a higher risk borrower and credit becomes significantly more expensive. You will need to use credit in order to rebuild your credit score, but you should be cautious about the interest rates and other fees that you may encounter during the process. Options for early credit building include:

  • Secured Credit Cards - When you obtain a secured credit card, you simultaneously place money in an account with the financial institution that issues the card. The credit limit on the secured card is usually the same as the amount of money you have on deposit. You can make purchases with the credit card and pay off the balance as with any other card, but the lender is protected from the possibility of default by the money it holds. Keep your purchases small as compared to the amount held by the bank, and pay off the balance in full each month.

  • Secured Loans - A secured loan works in a manner similar to a secured credit card, except that the bank holds in an account money sufficient to pay off the loan, or holds the proceeds of the loan, during the period of repayment. You will not have access to the money held as security for the loan during the repayment process, although the security requirements may change as the loan is paid off and less money is required to ensure payment of the balance.

  • Cosigned Loans and Cards - You may be able to get a loan or credit card based upon your having a cosigner, a person who guarantees payment of the debt in the event that you default. Don't take it personally if somebody you request to act as a cosigner says "No". Many close relationships are damaged or destroyed when a cosigner suffers credit damage and has to pay a debt on behalf of the debtor.

As you continue to build your credit, and in some cases without your taking those earlier steps, additional options will become available:

  • Credit Cards - Credit cards can help you boost your credit score, but also provide an easy means to again accumulate an unaffordable debt load. Never charge more to a credit card than you can afford to pay off in full at the end of the month.

  • Store Cards and Gas Cards - You may find that retail chains and gas stations are willing to issue you a line of credit in the form of a store or gas card on better terms than you can get for a credit card. The same approach applies as with credit cards: Don't borrow more than you can pay off at the end of the month and make all your payments on time.

  • Car Loans - Following bankruptcy, a car loan may be particularly costly as you may find that few lenders are willing to work with you and that those who offer loans are charging high rates of interest. In the post-bankruptcy period, try to find a car that you can afford to pay for in cash or with only a small loan, and then borrow a modest amount of money toward its purchase price. Make all of the payments on time and, if you're able, pay off the loan early, even if only a few months before the final payment would be due.

Whatever you do, don't miss payments: Any missed payment will have an immediate, negative impact on your credit score and will undermine the work you've done to rebuild your credit.

Using Credit Cards to Rebuild Your Credit

Most people receive at least one credit card offer during the year following their bankruptcy discharge, and many people receive several credit card offers. Following a Chapter 7 bankruptcy, a credit card company may be reasonably comfortable extending credit because of the lengthy waiting period before you can again file for Chapter 7 protection. That said, early credit card offers will likely carry high interest rates.

As previously indicated, you should not borrow more in any given month than you can afford to pay back in full. You need to consider your income and all of your debts and obligations when determining how much you can afford to borrow. If you are good at staying within those limits, you may consider applying for additional credit cards. If you are having difficulty managing your finances and find yourself falling back into debt, consider putting your charge cards into a drawer (or cutting them into pieces), paying off your balances, and starting again once your debts are paid down. Some people find that it helps to pay their credit cards off twice per month, using the credit card website to watch their balances and make payments, paying roughly half of the balance at the mid-point between bills and paying the remaining balance at the end of the billing cycle.

After you have held a credit card for a year or so, you may call the issuer and ask for a reduction in your interest rate. Don't close the account if they say "No", as doing so can potentially lower your credit score. You can instead make sure that you pay off that credit card balance each month, so that you never pay interest, or instead use other credit cards.

Carrying a Credit Card Balance

Although credit cards are an expensive way to borrow money, sometimes the best way to get your credit limit increased is to carry a balance. You may strategically pay more than your minimum payment but less than your total balance, but you should do so to demonstrate your ability to carry a balance while following the credit card's rules and not because you cannot afford to pay off your entire balance. Carrying an occasional balance while making minimum payments can inspire a credit card company to raise your credit limit, which will help you rebuild your credit score, but pay close attention to your interest rates and fees as they can quickly transform a small balance that you can afford to pay into a large balance that you cannot. As a rule of thumb, never carry a balance for more than a month or two -- that way you'll avoid getting into an unexpected amount of debt and will also immediately know if you're getting in over your head.

Credit Cards vs. Debit Cards

While a debit card may look like a credit card, it functions in a very different way. The use of a debit card is akin to the act of writing a check, and the charges you make to your debit card do not help you improve your credit. Credit cards also offer superior protection against acts of identity theft or fraud. Your credit rebuilding efforts should center around credit cards, with your debit card being as little as possible other than to access your bank's ATM machine.

Credit Options to Avoid

Certain forms of credit are likely to not only be costly, but to trap you into a cycle of unaffordable credit. Common credit options to avoid include:

  • Payday Loans - Borrowers who take out payday loans often find themselves struggling to pay off the loans when they become due, and even with the best intentions often end up deeper in debt each month.

  • Car Title Loans - Title loans not only generally carry unfavorable terms, they put you at risk of losing your vehicle.

Remember that some creditors are predatory and are hoping to take advantage of your financial situation in order to maximize their profits, and avoid those creditors and the financial products that they offer.

Getting a Home Loan

Although it is a longer-term goal, many people who declare bankruptcy hope to ultimately obtain a home mortgage. You may apply for a FHA loan a year after Chapter 13 bankruptcy, and two years after Chapter 7 bankruptcy. With some careful credit-building, you may find that a mortgage lender will work with you a lot sooner than you expect.

As with any early post-bankruptcy credit you can anticipate paying higher fees and interest than you would have to pay with better credit. However, once you obtain that mortgage and start making timely payments each month, you can expect that your credit score will rise significantly. Once you reach the point that you have demonstrated that you are not overextending yourself, are using credit responsibly, and are fully paying your home mortgage each month, better mortgage options may become available -- don't forget that you have the option of refinancing.

Monitor Your Credit Report

Following bankruptcy, you have two reasons to monitor your credit report:

  1. Mistakes Can Hurt You - Your credit report may include erroneous, negative information that is harming your credit. For example, you may find that a collection agency is reporting as active a debt that was discharged in your bankruptcy.

  2. You Want New, Positive Reports - Not all creditors will report your credit activity on your credit report. Some creditors don't report activity at all, and others may report only negative information. If you are trying to rebuild your credit, you want your hard work to show up on your credit report. If your creditors are not reporting your credit activity and timely payment history, pay them off and switch to creditors who will report your responsible use of credit.

Once each year, get your credit reports from the major credit reporting agencies at https://www.annualcreditreport.com/. That service is free. Any time you are turned down for credit, request a copy of your credit report from the creditor that rejected your application -- that report will also be free.

You can obtain a free credit report or free credit score from a number of commercial services, but in the process of requesting the free information be careful that you don't accidentally subscribe to a paid service that you don't want or need. Some companies that offer a free credit score will provide you with their own proprietary score, which may have little relationship to the scores seed and used by most creditors.

Copyright © 2016 Aaron Larson, All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you use a quotation, excerpt or paraphrase of this article, except as otherwise authorized in writing by the author of the article you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.

This article was last reviewed or amended on Jul 5, 2016.