When it comes time to repair your credit after bankruptcy, you—like a lot of folks—might decide it is best to become a cash-only citizen, foregoing the credit that got you into trouble in the first place.
You might be surprised to learn that this is the last thing you should do. To best repair your credit after bankruptcy, you must start using credit—wisely, of course. Indeed, of all the bankruptcy facts, the idea that you should use credit to rebuild credit might be the most important. In my book, 7 Steps to a 720 Credit Score (Philip Tirone, 2008), I explain that you can rebuild your credit score to 720 within just a few years of bankruptcy.
To do so, you must follow two rules:
Rule #1: Repair Your Credit After Bankruptcy by Opening New Lines of Credit
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No one can legally wipe a bankruptcy from your record, so beware of organizations that claim the contrary. That said, there is a ton of truth to the old adage that time heals all wounds. Equifax, TransUnion, and Experian—the three credit-scoring bureaus—place more weight on recent behavior than they do on things that occurred in the past.
Therefore, part of your credit-building campaign should focus on showing the credit bureaus that you have turned over a new leaf. In short, you want the bureaus to pay more attention to your recent good behavior than to your past irresponsible behavior. If you open new lines of credit and establish responsible habits, the bureaus will begin to see you as a new person whose bankruptcy caused you to open your eyes to smarter money-management habits.
Upon declaring bankruptcy, open three new revolving credit cards. Be sure these are major credit cards such as Visa, MasterCard, or American Express. You should have between three and five credit cards, so never waste a spot on a retail card that can be used only at select stores.
Use your credit cards at least monthly, and then pay the balance in full. Never let the balance exceed 10 percent of the limit.
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Also open an installment loan as part of your strategy to repair your credit after bankruptcy. Applying for a $20,000 car loan might not be a smart strategic move, not only because of the high interest rates you would pay due to your existing low credit score, but also because you would add a lot of debt to your credit report, which might cause your score to drop even more. Instead, take out a small loan—say $1,000—to buy a used car, a piece of furniture, or an electronic that you need. Then pay the loan off in six months.
In any case, be aware of high interest rates you will pay on installment loans and credit cards. Because of your bankruptcy, you will probably not qualify for the best interest rates. For this reason, you should always pay balances on credit cards each month. This way, you will avoid interest. For installment loans, paying the balance within six months will stop excessive interest rates while building your credit score quickly.
One final note about this rule: If you can, open every single account all at once, and as soon as you can after declaring bankruptcy. Equifax, Experian, and TransUnion will assign better credit scores to people whose accounts have been opened for long periods of time. Each time you open a new account, you lower the average age of your accounts. Though your credit score will initial dip if you open a bunch of lines of credit at once, it will start to bounce back after six months of timely payments. And your future credit score will thank you for opening accounts now.
By opening these new lines of credit, you can begin to repair your credit after bankruptcy by giving the credit bureaus new information on which they can judge your creditworthiness. Show them you have changed your patterns of behavior. In this way, you can immediately begin proving to the credit bureaus that the bankruptcy allowed you to turn over a new leaf and change your payment behavior.
Rule #2: Repair Your Credit After Bankruptcy by Making Payments on Time, Every Time.
The credit-scoring bureaus have a figurative red flag next to the names of people who have declared bankruptcy. If you make a payment that is one day late, even once time, your score will immediately plummet as the bureaus will assume you have reverted to your past behavior. So be sure to make your payments on time, every time.
To best repair your credit after bankruptcy, you must pay your bills immediately every single month. As well, you should learn all the other tips on how to build credit so that you can establish habits that best afford you to bounce back after a bankruptcy.