One of the great things about filing a bankruptcy is that it helps you get a financial fresh start. Instead of attempting to pay back debts that sometimes accrue at outrageous rates over a long period of time, you can discharge most debts and move on with life.
So how do I rebuild my credit after bankruptcy? In order to know how to rebuild your credit you need to know which factors influence your credit score. Credit Karma (which is free and which I highly recommend you use) explains and breaks down these factors into six categories. Three of the categories have a “high-impact”, one has a “medium-impact”, and the last two have a “low-impact” on your credit score.
You’ll want to pay attention to ALL categories but you should be most concerned about categories with high impact and the categories within your control. In the table below I have each of the categories listed along with an impact level and a control level.
| Factor | Impact | Control |
|---|---|---|
| Credit Utilization | High-Impact | High-Control |
| Payment History | High-Impact | High-Control |
| Derogatory Marks | High-Impact | High/Medium-Control |
| Age of Credit History | Medium-Impact | Medium-Control |
| Total Accounts | Low-Impact | Medium-Control |
| Credit Inquiries | Low-Impact | Medium-Control |
Because the first three categories have the highest impact, you should focus on these categories the most. I will discuss each of the categories below but if I were to boil the rules down to a formula to follow it would be these two rules:
1. Make all your payments on time
2. Use your credit, but use it responsibly
Following these two rules will have a high-impact, positive effect on your credit score.
1. Credit Card Utilization (& Credit Utilization)
One factor of your credit score is the amount of credit you are utilizing. This is a high-impact, high-control category which means this is a category you’ll want to focus on. While you don’t want to use all of your available credit, you also don’t want to use none of your available credit. The basic rule is to keep your credit utilization under 30%. For example, if you have one credit card and a credit limit of $1,000, you would not want to use more than $300 of credit on your card at any one time.
The funny thing about credit is that you have to use credit to get credit, a kind of chicken/egg problem. Fortunately there are easy ways to get credit without credit.
Secured Credit Card
One of the easiest, and safest, ways to build credit is with a secured credit card. With a secured credit card, you place a deposit of money with the credit card processor (typically between $50 to $200) and then you can spend on credit and pay off the balance at the end of the month. What’s so great about the secured credit cards is that the credit card company is completely protected by your deposit. And for you, the consumer, you can easily qualify for a secured credit card and start building credit.
I don’t have a specific secured credit card that I like but I know that Nerd Wallet has a good list of secured credit cards that they like.
Car Loan
People who file for bankruptcy are surprised when shortly after they file they are inundated with mail from banks and lenders wanting to finance a car. They know that not only that you are getting rid of a lot of debt, you are also not able to file another chapter 7 bankruptcy for eight years.
Most people need a car to get to work and get around in general so buying a car is not a bad idea. However, because you just filed for bankruptcy you are probably not going to be able to get a good interest rate. I suggest you purchase an older but reliable vehicle in the $5,000 to $8,000 range. You will be paying a higher interest rate but 20% on $5,000 is a heck of a lot less than 20% on $20,000.
A car loan is a great way to take on necessary credit in order to rebuild your credit.
2. Payment History
Payment history is another high-impact, high-control category. There might be some missed payments or late payments in your recent past but that is water under the bridge. You can control your future payments. And if you’ve filed a bankruptcy this should be an easier category for you because you no longer have to make payments to your creditors.
It’s very important to make ALL of your payments online. Many creditors and most banks make this easier by allowing you to set up automatic payments.
3. Derogatory Marks
Derogatory marks is a high-impact, medium-to-high control category. This category should actually be a “variable-control” because many derogatory marks can be difficult to avoid. Derogatory marks include bankruptcies, foreclosures, accounts in collections, and liens. Some bankruptcies can be avoided by wise financial decisions but there are a fair amount of bankruptcies that are completely out of the control of the debtor.
Typically these marks stay on your credit for a period of 7 to 10 years so it’s best to avoid these marks like the plague. Making payments on-time, living within your means, and having a rainy day fund in your savings are the best ways to make sure you avoid any derogatory marks in the future.
4. Age of Credit History
This is a medium-impact, medium-control category. The credit bureaus looks at the average age of your open credit accounts. The longer the credit history the easier it is for lenders to judge your credit worthiness. Again, this takes into account only your open credit accounts. For this reason it’s generally not a good idea to close an open credit account even if you aren’t using it.
While this category is classified as a medium-control category, it would be more aptly described as a high-control category that takes a long time to improve. While you can utilize credit today and you can make payments today to improve your payment history, you can only increase your age of credit history by waiting for time to pass.
That being said, age of credit history is a medium-impact category and an important category to keep in mind.
5. Total Accounts
Total accounts is a low-impact, medium-control category. Total accounts includes all of your credit cards, lines of credit, student loans, mortgages, or other lines of credit. Generally speaking the higher the number of credit accounts means that you have been approved for credit by more lenders. Because this a low-impact category, you shouldn’t worry too much about this category. In fact, it’s probably best to avoid more accounts if you have a tendency to spend a lot on your credit.
6. Credit Inquiries
Credit inquiries is also a low-impact, medium-control category. Whenever you apply for credit whether it’s a mortgage, a student loan, or a credit card, a hard inquiry is reported on your credit report. Typically the negative affect of this goes away after a short period of time. One thing you’ll want to avoid is having several hard inquiries in a short period of time.
While there are many factors that affect your credit score, you should focus on those categories that have a high impact on your score—credit utilization, payment history, and derogatory marks. Again, if I were to sum the advice into two simple rules it would be:
1. Make all your payments on time
2. Use your credit, but use it responsibly
Sean Wood 