No one wants to file for bankruptcy. It’s a monumental decision that can have a long-standing impact on your finances and credit. Still, challenges and unexpected expenses arise, and bankruptcy does happen. Know that you’re not alone. In 2024, there were more than 494,000 non-business bankruptcy filings and more than 23,000 business bankruptcy filings in the US.
The good news is that recovering from bankruptcy is possible. You just need to know how to rebuild your credit.
What is Bankruptcy?
Bankruptcy is defined as a legal process, helping individuals and businesses who cannot repay their debts. The federal court gets involved and helps the borrower out of their financial constraint, usually by liquidating their assets to repay lenders or setting up a repayment plan.
Types of Bankruptcy
There are several different types of bankruptcy, which include: Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13, and Chapter 15. However, the most common types of personal filings are Chapter 7 and Chapter 13.
- Chapter 7: In a Chapter 7 bankruptcy, your assets are liquidated to repay your lenders. Some debts will be discharged without repayment. Some forms of unsecured debts are bankruptcy-safe and cannot be dismissed, such as alimony, child support, some taxes, liens on property, and some federal student loans.
- Chapter 13: A Chapter 13 bankruptcy is a reorganization of debts. Individuals typically choose this option when they want to keep their largest assets (such as their home and car). The court will work with the lenders to establish a repayment plan for at least a portion of the outstanding debts. Most repayment plans last between three and five years, after which any outstanding unsecured debt may be discharged.
Common Reasons People File for Bankruptcy
People file for bankruptcy when their bills are so overwhelming that they cannot see themselves ever finding a way to repay everything. There are many ways an individual can end up in a situation where they’re insolvent, but some of the most common reasons are:
- Job loss
- Unexpected and significant medical debt
- Unexpected expenses from natural disasters, theft, and other emergencies
- Divorce or a partner break-up
- Consumer debt (overspending)
- Student loans
- Poor financial management
- Income tax debt
- Business
- Financially supporting extra family members
- Unaffordable mortgage
- Bad investments
- Loss of life savings
What Does Bankruptcy Do To Your Credit?
Bankruptcy negatively affects your credit. After a successful bankruptcy filing, you’ll likely have difficulty getting approved for new credit or loans, including credit cards, mortgages, auto loans, and personal loans.
Bankruptcy significantly lowers your credit score. Also, it’s listed on your credit report, so lenders can see the bankruptcy when you submit a new credit or loan application. If you file a Chapter 13, it will stay on your credit report for up to seven years. A Chapter 7 bankruptcy shows up on your report for up to 10 years.
How to Rebuild Your Credit After Bankruptcy
One of the hardest parts of bankruptcy is trying to get your footing back after it’s over. When lenders see a bankruptcy on your credit report, they hesitate to give you credit. However, that’s a vicious cycle because you need the new credit to rebuild.
The good news is that rebuilding is possible. Your credit score isn’t permanent, and you can start making improvements today.
Here are the six steps you can take to get your credit back to a healthy place:
1. Get a Secured Credit Card
After filing for bankruptcy, you may struggle to get approved for a credit card. So, sign up for a secured credit card instead.
A secured credit card is basically like a debit card. You pre-load money onto the card, and you can only spend the funds you’ve added, so you can never go into debt. But, unlike a debit card, the transactions from your secured card get reported to the credit bureaus and are added to your credit report.
Since you can’t go into debt, these transactions only positively impact your credit.
2. Become an Authorized User
Another way to get access to credit is to become an authorized user. When you’re an authorized user, you can use someone else’s credit card.
However, considering you filed for bankruptcy, your friends and family might hesitate to make you an authorized user on their card. A compromise is to ask to be added but never take the card details or a copy of the card for yourself. This way, the other person continues to use their card, and all that data is added to your credit report.
A note here that you want to ensure you’re partnering with someone financially responsible. It’s not just positive transactions that will be recorded on your credit report. If that person misses or makes a late payment, it can result in a negative item being added to your report, which can further harm your credit.
3. Make All Payments On Time and In Full
You need to show lenders that despite your history of bankruptcy, you can be a reliable borrower. The best way to do this is by making all your payments on time and in full. Your payment history is the biggest component that impacts your credit score, so these on-time payments will help increase your score over time.
Consider signing up for autopay whenever possible to make payments seamless.
4. Keep Your Credit Utilization Ratio Low
Your credit utilization ratio is the credit available to you versus the credit you spend every month.
In order to have a positive impact on your credit score, you need to keep your utilization below 30%. So, if you have two credit cards, each with a $500 balance, you shouldn’t spend more than $300 across both cards monthly.
Lenders need to see that even if you have access to a lot of credit, you don’t rely on using it every month.
The two ways to keep credit utilization low are:
- Reduce spending on credit
- Increase your available credit
5. Monitor Your Credit Report
Your credit report is supposed to reflect your creditworthiness as a borrower. It should be a fair, accurate representation of you. However, credit reports often have mistakes that can drag your score down. A 2024 study found that more than 25% of people have a serious error on their credit report.
You can’t afford anything that will negatively impact your credit. Review your free credit report regularly to catch and dispute any errors.
6. Avoid Repeating Old Mistakes
Lastly, take a moment to be honest with yourself. Why did you get into a financially overwhelming position the first time? You may have a problem with overspending. Or, you didn’t have an emergency fund and couldn’t handle unexpected bills. Whatever it was, try to learn from the past. Make sure you don’t find yourself in the same situation. Your credit can only recover if you continue to make sound financial decisions.
Start Today
Boosting your credit after bankruptcy will take time, which is precisely why you need to start taking steps today to rebuild. The sooner you start, the sooner you’ll see that credit score rise and rise.
It might take 7-10 years for the bankruptcy to disappear from your credit report, but if you start practicing good financial habits now, lenders will start trusting you again long before that.
You might also be interested in: 10 Best Practices for Managing Your Credit Utilization
