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Rebuilding credit after bankruptcy

IFM Banckruptcy

Bankruptcy, as outlined by the United States Bankruptcy Code, states the phenomenon as a legal proceeding which is carried out to free individuals/businesses from their debts.

“Creditors still have an opportunity for repayment with the bankruptcy process. Bankruptcy is handled in federal courts,” the act states.

While opting for financial protection under the bankruptcy clause can provide a business with some degree of relief, at the end of the day, it impacts the entity’s credit. Also, the credit scores of those running the organisation.

After filing for bankruptcy, an entrepreneur needs to rebuild his/her credit, which will take time and consistent effort, but necessary if the person wants to start a venture afresh.

Does bankruptcy affect credit?

Before determining a person’s credit history, lenders always keep the ‘Payment History’ in their mind. When a business files for bankruptcy, the individual running it will not be repaying covered debts in full as per the original credit agreement. However, it will severely downgrade the person’s credit score.

“A bankruptcy filing will appear on an individual’s credit report for up to 10 years, making it difficult to obtain credit or loans in the future. An entrepreneur may also have difficulty obtaining credit from suppliers or vendors, as they may be hesitant to extend credit to a business that has filed for bankruptcy,” suggested.

Remember, bankruptcy wipes away/reduces debt that the entrepreneur cannot afford to pay and tells the world that he/she is at credit risk. It will make it tough for the concerned person to even borrow and spend. Getting a credit card, a personal bank loan or a mortgage will also be very difficult.

However, there is another side of the coin. Bankruptcy also comes with the prospect of clearing negative items from the entrepreneur’s credit report, thereby leaving only the bankruptcy itself as a negative remark. The person can, in fact, discharge most of the debts and start afresh.

From there on, lenders may not approve certain types of credit or they may clear the credit application with higher interest rates or other unfavourable terms.

In the United States, negative FICO scores (creditworthiness assigned by credit bureaus) take down credit scores too. An entrepreneur with an average 680 FICO score will lose between 130 and 150 points in bankruptcy. Someone with an above-average 780 score will lose between 200 and 240 points. Both will become “Risky Borrowers”, making it difficult to get loans/unsecured credit.

“On the other hand, if your score is in the 400s or 500s when you file, it’s possible that your score may experience a boost from the bankruptcy filing. People in this score range have seen credit score boosts as high as 50 points after filing for bankruptcy,” explained the process.

Bankruptcy under Chapter 13 stops collection actions and creates a plan for borrowers to partially repay creditors over a fixed number of years. Chapter 7 eliminates most unsecured debts, meaning the creditors cannot recoup what they advanced.

Chapter 7 bankruptcy will negatively affect the FICO score for 10 years. A Chapter 13 filing, on the other hand, will remain on the person’s record for seven years after receiving a Bankruptcy Code discharge/dismissal.

“Bankruptcy’s impact on your credit score will also vary according to how much debt you had discharged and the ratio of positive to negative accounts on your credit report. This is because major credit score factors such as late payments and credit card utilisation will be reset,” commented further.

Can the bankrupt person get a credit card?

Yes, he/she can, but it will be difficult after filing for bankruptcy. Lenders will see the person as a ‘Higher Risk’.

The practical way out here will be availing of a card tailored for rebuilding credit. A secured credit card, which anyone can get even after entering bankruptcy, typically has a credit limit equal to the amount of security deposit that is provided.

“However, some unsecured card issuers won’t pull a credit score or may extend a line of credit even if there are blemishes on someone’s credit history. Just be aware that these types of cards typically have extremely high rates and an abundance of fees. A secured card is likely the better option with lower costs,” noted.

However, it must be clarified here that the bankrupt persons cannot apply for a credit card, while the legal proceedings are on. You will be requiring court approval to opt for any fresh credit line.

Under Chapter 7, bankruptcy takes approximately four to six months after the initial filing to be completed and the applicant’s debts are discharged. A Chapter 13 bankruptcy takes somewhere between three to five years, as the clause will restructure the debt that the concerned person will pay off over time. In both cases, if the person is applying for a credit card during the legal proceedings, he/she will be requiring court approval.

Charting the recovery path

After bankruptcy filing, find out the accounts which are still open. While bankruptcy cancels most debt, some need to be paid as well. While paying down these debt balances will lower the debt-to-income ratio, that will only happen when the payments are consistently on time.

Pay attention to your credit balances, which will directly impact the credit utilisation ratio. Reduce credit card usage and pay down debt balances whenever possible.

Save money for each payday, and build emergency savings. This will help you to avoid incurring future debt that could impede rebuilding credit.

Avail a secured credit card to rebuild your credit.

Some of the secured card issuers allow cardholders to move on to an unsecured card after making consistent and on-time payments. This will make sure that you do not need to apply for a new card as your credit starts to improve.

Talking about unsecured cards, product issuers will not check your credit score and will even extend a line of credit irrespective of your credit history. These cards, however, come with fees and sky-high rates, so be careful about that. Secured cards, on the other hand, provide lower costs.

After getting your new card, focus on improving your credit score to qualify for better credit cards and loans with favourable terms.

Pay your monthly bills on time every month to improve your FICO Score. Pay off your existing debts. Keep your credit utilisation ratio low, as the amount of total credit you use as a percentage of your credit limit will also weigh in at 30% of your score.

Sign up for something like United States-based ‘Experian Boost’, which counts your payment behaviour from one of your linked checking accounts. There are digital tools like American Express’ FICO Score Planner, which maps out a blueprint of credit-building actions.

Use your secured credit card to build good payment behaviour and improve your credit profile. Your credit score will rise steadily over time. So be patient and practice responsible spending habits.

Also, opt for a credit builder loan. You can also get a secured loan that allows borrowing against savings. The payment activity for a credit builder loan will be reported to a major credit bureau, which will improve your credit score too.

Get a co-signer to boost the chances of your loan getting approved. In this case, lenders will consider the co-signer’s credit score too. And the co-signer will be equally responsible for paying the loan back. Also decide on things like for what purpose, the line of credit will be used, what will be the credit limit, and a repayment plan.

On the personal front, control your spending habits, as overspending leads to more debt. Explore money management apps. Even 21st century banks are also offering similar options. Check your bank balance daily, and check regularly whether your spending limit matches up with your monthly budget. Most importantly, avoid piling up a massive credit card bill at any cost.

Patience is the key here

If a bankrupt entrepreneur is making consistent payments, and has a low credit utilisation ratio and low debt-to-income ratio, he/she will see positive changes to their credit score after approximately six months (from the time they filed their bankruptcy plea).

Take a long-term approach here. Understand that the mention of bankruptcy will be on your credit report for seven to ten years. It is up to you to stay patient and act responsibly to improve your credit score.

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