How filing bankruptcy can improve your credit score.
For those individuals who are up to date on their payments and have their credit debts under control, filing bankruptcy would drastically hurt their credit score. But for those buried up to their neck in debt, facing insurmountable balances on their credit cards, or dipping into their savings to pay the monthly bills, bankruptcy may be the best way to stop the bleeding and get their credit score moving in the right direction.
Before we move too far along, let me first establish exactly who this information is intended for. The only people whose credit score may benefit from filing bankruptcy are those individuals with “repayment problems.” Repayment problems include late payments, missed payments, very high balances or accounts in collection. Each time a repayment problem is reported to the credit bureaus, your credit score is affected, driving it further and further from perfect. Filing bankruptcy can help debtors with repayment problems because they likely already have poor credit scores. Sure, after coming out of bankruptcy you are going to start with a low credit score, and are going to have to work to bring it back up, but it may be the fastest way to get your credit problems under control and your score moving in a positive direction.
Here’s how it works. When an individual files bankruptcy, most unsecured debts are wiped clean from the debtor’s credit report. Credit card debts are the most common form of unsecured debts that are stripped away. For many credit card companies, known as unsecured creditors because they extend credit without having an interest in property, an individual who has recently filed bankruptcy is an appealing candidate to extend credit to. Why? Because, after filing bankruptcy, another petition cannot be filed for eight years. Without being able to file bankruptcy, a debtor cannot discharge their unsecured debt. Essentially, unsecured creditors look at debtors coming out of bankruptcy as a more secure investment than debtors who have never filed bankruptcy because their unsecured debt cannot simply be discharged in another bankruptcy for eight years.
Now, if you decide to file bankruptcy, and you emerge with your discharge, there are a few steps you can take to rebuild your credit score:
- Get new credit cards. Although credit cards were what got you into this mess, responsible use of credit will get you out of it. As you begin to show that you can properly use credit, your score will rise.
- Ask a trusted friend or relative if they would allow you to become an authorized user on their credit card. Your bankruptcy will not show up on their credit history at all. Plus, the credit history from that card will be reflected on your credit report. The only drawback is that your credit score will be damaged if your trusted friend or relative files for bankruptcy.
- Keep your monthly balances low and try to pay them off each month. This type of credit activity shows the credit bureaus that you have changed your ways and that you are no longer a credit risk.
- Monitor your credit report. Keep an eye out for any irregularities and clear them up as soon as possible.
- Ask creditors whose debts were discharged in your bankruptcy to stop reporting your account to the credit bureaus. Creditors do not have to comply since discharged debts will continue to be reported for seven years after filing, but it never hurts to try. Getting discharged debts removed from your credit report can greatly improve your score.
I must clarify that the type of credit that will be extended your way after filing bankruptcy will be less appealing than the credit that was available to you before filing. The types of credit cards that will be offered in the immediate future will be cards with high interest rates or cards that must be secured with collateral, otherwise known as secured credit cards. Larger loans, like home loans, will be harder to qualify for immediately after filing, but by slowly building your credit score after filing, you could qualify for a home loan within a couple of years.
Filing bankruptcy is not a decision to be taken lightly. It has severe consequences and can be a long, drawn-out process. If there is any way you can work out a repayment plan with your creditors or adjust your finances to get your credit problems under control, those avenues should be explored before filing. But if you’re fighting an uphill battle and there does not appear to be a light at the end of the tunnel, perhaps it’s time to seek expert advice and strongly consider the possibility of filing for bankruptcy.
Jared Bellum is a contributing author to this blog and has been admitted to practice law in the state of Washington. He practices in the fields of bankruptcy, business start-ups, and estate planning. JD Bellum, Attorney at Law, PLLC works in association with the Law Offices of Richard D. Seward