Bankruptcy and your Credit Score

Bankruptcy can be a double-edged sword with respect to your credit score (i.e., FICO score) and your ability to obtain loans. On one hand, bankruptcy can erase much of your debt and thereby improve your creditworthiness. On the other hand, bankruptcy stays on your credit report for years (for example, Chapter 7 bankruptcy stays on your credit report for ten years) and typically means a higher interest rate when you do get a loan. Once you emerge from bankruptcy, there are various ways to rebuild your credit. Some of these practices, such as setting aside money for bills, may also help you to avoid another bankruptcy.

If you already own a home or a car, keeping up with your remaining payments can improve your credit by showing that you are now managing your bills in a timely manner. While bankruptcy may help you to avoid debt, reaffirming (voluntarily agreeing to pay) your mortgage or car payments shows financial responsibility and helps you to keep those assets.

Another way to improve your credit score is to get a credit card. However, this may not be a good option if credit card debt led you to bankruptcy in the first place. Only charge items that you are sure you can pay at the end of each month. While carrying a balance on your card will not necessarily ruin your credit, it will cost a substantial amount of money – money that you could otherwise put toward paying other bills or rebuilding your savings. Credit card interest rates are often in the neighborhood of 25%, which means that for every four dollars you put on the card, you pay one dollar in interest. If you want to “start small” with regard to how often you use your card, consider a store or club credit card (many department stores, gas stations and membership benefit clubs offer credit cards with higher rewards on certain categories of purchases).

Opening a checking and/or savings account can also show lenders that you are now managing your finances (e.g., if you never overdraw your checking account, it shows that you keep track of your account balance and do not buy items that you can not afford). Opening accounts at a bank or credit union can also pave the way for a future line of credit at that institution (particularly at credit unions). As a result, it pays to compare banks’ and unions’ loan interest rates and eligibility criteria before opening a new account, as it is prudent to open an account where you think you will end up applying for a loan.

Regardless of precisely how you go about rebuilding your credit, the most important things to do are to pay your bills on time and save as much money as you can. Set aside money for bills that you know are coming up and cut unnecessary expenses (e.g., cook rather than dining out and borrow books, albums and films from the library rather than buying them).