After Bankruptcy

Bankruptcy provides you with an opportunity to come out from under the heavy load of debt and start fresh.  When you receive your discharge, however, where do you go?  What do you do?  How do you rebuild? 

The answer is simple, you start.  This article will walk you through your first steps of rebuilding your credit and offer advice and helpful websites to visit as you plan your new future.

Everyone defines success differently.  Your definition of success, in the first few months after bankruptcy, cannot be based on possessions and toys.  Success comes from the ability to pay debts, save for emergencies, budget for expenses, and plan for the future. 

So, let’s start.  What is the number one thing to do? 

1. Never let it happen again.  Learn from your mistakes or misfortune. 

Bankruptcy is not a financial planning tool.  Sit down and look at your spending habits, your business plan, and your financial history.  If overspending was a problem, you must develop and—more importantly—stick to a budget.  If you think Starbucks is a necessary start to your morning, it needs to be time for Folgers in your cup. 

Start saving.  Save something every pay period. Get into the habit of putting money into an emergency fund to cover medical expenses, car problems, and unexpected costs.

undefinedundefinedundefined2. Live on Cash.

29% of households have more than $1,000.00 in credit card debt.  One late payment tacks on penalties.  If you are close to your credit limit, the credit card company can arbitrarily decide to lower your limit—as a risk management tool—leaving you suddenly over your limit. Overage fees and penalties then apply, and typically, a once usable tool becomes an awful liability.

Once you declare bankruptcy, commit to living on cash.  Pay for only the things you need to survive (rent, food, electricity, car, gas, etc.) and save everything else.  Consider each purchase and buy only what is necessary.  Covenant not to buy “things” that are not going to help you rebuild your credit.  Assign your money a purpose.  If you choose not to protect your money, it cannot protect you. 

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3. Stick to a Budget.

There is no stronger tool for keeping your money working for you than by budgeting wisely.  There are hundreds of budgeting tools available.  I have listed three at the end of this article.

In brief, list all your sources of income and determine how much you receive after taxes each month.  That is the MAXIMUM you can spend in a given month.  Then list all your expenses, starting with necessities and tangibles like: rent/mortgage, utilities, and car payments. 

Pay your bills first and then attempt to save 25% of your Net Income.  When you determine how much you spend on food, entertainments, and clothing, stack that against your Net Income minus savings.  If that total exceeds your Maximum, you must determine what you will cut back on. 

Spend only what you have. 

4. Build credit with SECURED credit cards.

Having just said, “Live on Cash” you may wonder why credit cards come next.  Unfortunately, your new excellent saving habits and cash purchases are not reported to credit bureaus.  To quickly rebuild your credit score, you need to have two types of credit:

Installment: auto loans, student loans, or mortgages

Revolving: credit cards or lines of credit

Secured credit is tied to a tangible object used as collateral to guarantee your ability to repay on installments.  Most secured credit is in your home or car.  Depending on your situation, a bankruptcy may help you bring past or overdue payments to your secured creditors current, which in turn more rapidly boosts your credit score. 

Revolving accounts (credit cards) are typically unsecured and, after bankruptcy, carry extremely high interest rates, high annual fees, and very unfavorable terms.  However, you need installment and revolving accounts to build credit. 

The secret is that you can obtain favorable interest rates and reasonable terms with secured credit cards.  These credit cards are tied to the amount of funds you put into a savings account at a bank.   

You guarantee your repayment of the credit card debt with the funds you have placed in the account.  You can wisely use the credit card by paying back what you owe in two months.  That way you build credit on revolving accounts with less worry. 

These cards carry reasonable annual fees, report to the major credit reporting bureaus, and may convert to an unsecured credit card in 18-24 months. 

5.  Obtain or Pay Down Installment Loans.

Also available are secured installment loans.  Like the secured credit cards, you develop credit by placing money in a bank account, then taking a loan for some of that amount.  Pay back the loan (simply take the loan, put it in another savings account, and then pay the money back—plus interest—with regular payments), and you are on your way to rapidly rebuilding credit. 

Another installment loan typically not dischargeable in bankruptcy is your student loan.  Do not look down on your student loans.  These are mighty allies in rebuilding your credit.  Paying down existing debts is an extremely powerful method of improving your credit score.

Lenders will typically look back over the last 18-24 months in determining the risk in lending you money for a home purchase.  Unlike an unsecured credit card, the lender may foreclose on your home if you fail to make payments, so your recent credit history tends to be  more important in home purchases.

If you are looking to purchase a home, wait at least two years after your bankruptcy.  If you can show on-time payment on your revolving (see 4) and installment (#5) credit, you may qualify for an FHA loan rather than your typical high-interest rate mortgage available to those just out of bankruptcy.  FHA loans typically carry interest just a half point higher than normal rates. 

6. Pay every bill you have ON TIME.

There is no substitute for on time payment.  The number one thing a lender will check for is on time payment.  Pay your rent on time; pay your utilities on time; pay your credit cards, your car loan, your mortgage, and your student loans on time. 

7. AVOID Payday loans. 

Bottom line: if you do not have the cash in hand to purchase what you want, you do not need it.  If you utilize the tools given so far, you will not need a loan to “tide you over” until the next payday. 

undefinedundefinedundefinedPayday loans carry staggering interest rates from 911% for a one-week loan; 456% for a two-week loan; to 212% for a one-month loan.  You may pay $17.50 in fees alone for every $100.00 you borrow.  When your term is over and you cannot repay, then an extension costs an additional $17.50 per $100.00 (now including interest). 

Payday loans are an inescapable TRAP to be avoided at all costs.  Borrowing money at triple-digit interest rates will never be a smart solution.

8. Buy a USED CAR.

Look for car dealers that call themselves “bankruptcy friendly.” Buy a used car so you do not get hit with the depreciation that occurs during the first two years of a new car purchase. 

If you are a Chapter 13 debtor, you may need the Trustee’s permission to purchase the car.  Find a way to make it work.  Installment credit comes in only a few ways.  Make sure you utilize the tool of purchasing and paying for a car. 

You may be required to have a co-signor on the loan.  Ensure that you and your co-signor have a frank discussion about responsibility of payments and the ability, and willingness, of both of you to make payments.  Finally, make your payments on this car religiously. 

9. Avoid Credit Repair Scams, Bankruptcy Erasing Scams, or any other “Excellent Credit Now” claims.

Nearly anyone who claims to have a miracle cure for bankruptcy is only going to take your money and leave you with nothing.  The only way to repair your credit is by developing a payment history of solid, on time payments. 

You may find yourself a target for these scams. 

Save yourself time, money, and heartache by focusing on the steps above rather than “quick and easy” scams.  When your credit report glows with “Pays As Agreed” marks, you will be on your way to better credit, better interest rates, and a better life.

10. Pay all Reaffirmed Debts.

In your bankruptcy, you likely had the opportunity to reaffirm some of your debts.  You may have chosen to continue paying on your car or your mortgage.  Whatever those debts, pay them first.  Put money aside so you can make your Plan payment (if you are a Chapter 13 debtor) or your reaffirmed debts.  Failing to pay those debts will adversely affect your credit.

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Bankruptcy started a whole new chapter in your life.  Make it a great chapter and commit to develop a budget, save for emergencies, develop credit in safe ways, avoid debt for non-necessities, and pay your debts – in full and on time.  Take these 10 simple steps today for a better credit score tomorrow.

No matter what you do, develop a plan you can live with.  The reason no New Year’s resolution diet survives January is because we take too big a bite.  Pick changes you can live with, but sacrifice some “wants” now to plan for your future, save for an emergency, or just increase your peace of mind.