After Bankruptcy

So you have bankruptcy behind you. That’s great. But you want to make sure that you don’t get back in that situation again.

Three Steps to Rebuilding Your Credit After Bankruptcy

To start rebuilding your credit, you must (1) get any nondischargeable debts back on track; (2) start building a history of regular on-time monthly payments and responsible use of credit accounts; and (3) avoid taking on unnecessary debt.

(1) Making arrangements to pay any nondischargeable debts. If you have non-dischargeable debts, such as student loans or certain taxes, you will need to contact the creditor to make arrangements to pay them. If you do not arrange to pay these debts, the creditors can begin collection action and can report delinquencies on your credit report.

Nondischargeable student loans. As to student loans, you should receive a forbearance for the time you were in Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, the loans would have been paid the same as other unsecured creditors but would also continue to accumulate interest. In either case, you need to make arrangements to get these loans back on track after bankruptcy.

Fortunately, there are various programs to lessen the burden of federal student loan payments that are worth exploring to see whether you might qualify, including income-based repayment and occupation-related and public service loan forgiveness. Some private lenders have hardship programs of some kind. In any case, try to avoid deferments, as the accumulating interest may cause the debt to build to an unsustainable level.

Nondischargeable taxes. Regarding non-dischargeable income taxes, contact the IRS, state revenue department (e.g., the Pennsylvania Department of Revenue), or the local taxing authority to make payment arrangements. (The IRS will typically accept a monthly payment of around 2 percent of the total.) However, if you have a substantial tax debt, you may need the assistance of an attorney to work out a settlement. If you can pay off these tax debts in a lump sum at some point, you will likely save substantial interest and fees.

There are other nondischargeable debts, such as criminal fines and restitution, alimony, and child support. If you have any of these debts, be sure to consult your attorney.

(2) Using a secured credit card or small vehicle loan to help build a record of on-time payments.

(a) Secured credit cards. To begin rebuilding your credit, you may wish to obtain a secured credit card. A secured credit card uses money deposited in a bank account as collateral for the credit card. The creditor can take the money in the account only if you default. Some banks offering secured cards do not require a credit check, and it may be easier to obtain a card from them. However, be sure to shop around. Some secured card providers charge excessive fees and interest. Also, you should make sure the provider reports to all three credit reporting agencies (not all do).

It is important to use no more than twenty percent of your available credit on your secured card (or any credit card). Thus, if you have a limit of $500, avoid carrying a balance of more than $100 on the card at any one time. The purpose of this card is to rebuild your credit, so responsible use is essential. If you are a couple, it is a good idea to have a separate card for each of you.

Quick Note: A secured credit card is not the same thing as a prepaid credit card. Although very convenient, prepaid credit cards do nothing to improve your credit.

(b) Vehicle Loans. If you need a vehicle, a car loan is another way to rebuild credit. However, I do not suggest getting a car loan just to rebuild your credit. See below for information on obtaining a vehicle loan after bankruptcy.

(3) Avoid unnecessary post-bankruptcy debt. The main traps for post-discharge debtors are (1) the temptation to open too many credit accounts and (2) incurring too much debt.

Too many accounts: In some instances, post-bankruptcy loans and credit accounts may be available. However, I do not recommend obtaining multiple credit accounts after bankruptcy to try to improve your credit score. Some post-bankruptcy debtors believe that the more accounts they open, the faster they will rebuild their credit. That mindset is a recipe for disaster. With few exceptions, debt is not your friend. One or at the most two credit cards should be enough for anyone.

Keep in mind that each time you apply for credit, the inquiry reduces your score a bit. Moreover, if you have too many accounts, you may be tempted to over-utilize credit, which may severely damage your income-to-debt and debt-to-available-credit ratios (see below). The key to rebuilding your credit score is the responsible use of credit and living within your means.

How much is too much debt — Understanding the income-to-debt ratio and debt-to-available-credit ratio? One reason debtors often see their credit rating rise soon after bankruptcy is the reduced income-to-debt ratio. In other words, the amount of debt that they have compared to their income is now much lower. The income-to-debt ratio is a significant factor in credit scoring. Therefore, you want to keep this ratio low.

Just as important is the debt-to-available-credit ratio, which measures the percentage of the debt you use compared to your available credit. Limiting your use of unsecured credit to less than twenty percent of each account’s available credit will show that you are a responsible user of credit. Maxing out credit is a sure way to damage your credit rating. Of course, I prefer to see clients pay off their credit cards each month and avoid revolving balances.

Carolyn Secor P.A. focuses its practice in the areas of Bankruptcy and Foreclosure Defense in Clearwater, Florida. For more information, go to our web site www.BankruptcyforTampa.com or call 727-254-1704.