This monthly series by personal finance specialist Amanda Reaume focuses on how to improve something that many people overlook: your credit score. These posts will give you tips and tricks to improve your chances of getting approved for better rates when you apply for credit – leading to better student loans, car loans and even mortgages.
People who haven’t been through bankruptcy may think it’s an easy way out. They might believe that people who are overwhelmed with their debt simply go to court and get it discharged, putting an end to their worries. Anyone who has gone through bankruptcy, however, knows that’s not the case. The process is difficult, expensive and hurts you well down the line. Once it’s over, your bankruptcy stays on your credit history for up to seven years, dragging down your credit score.
Improving your score after bankruptcy is a long process that should be started as soon as possible in the event you need to borrow money in the future.
First Things First
Three months after your debts are discharged, you should receive a copy of your credit history. You are entitled to one free report per year, but you can pay to obtain additional ones. Both Canadian credit bureaus, TransUnion and Equifax, send your free report via mail, but you can get it online for a small fee. Because your report can actually vary, it’s important that you get your credit report from both bureaus.
When your reports arrive, check them for errors and immediately report any you find to the credit bureau. By law, they must investigate and take action within 30 days. Once you’ve completed this part of the process, recheck the scores with both bureaus to see where you’re at. Even though you have to pay again, this is worth the effort.
Avoid Unhealthy Credit Habits
Spend some time figuring out what led you to become bankrupt in the first place. For some people, it occurred after they continuously charged more and more to their credit cards thinking they could pay it off. For others, it’s a major event such as losing one’s job or dealing with illness, likely meaning they received little to no income and relied on credit cards for a long period of time.
The next thing to do is make a post-bankruptcy budget. This budget should have a big savings buffer - you should aim to put at least 20 to 30 per cent into a savings account or emergency fund. It’s critical that you build up this buffer so in the event of another emergency, you don’t need to rely on your credit cards.
If you’re an impulse buyer, it’s also important that you figure out how to control how much you spend so that you don’t get into the same situation again. That might involve going to therapy to better understand and ultimately curb your spending habits.
Credit Options after Bankruptcy
Your next priority is to look into credit options for those who have gone through bankruptcy. Because your bankruptcy is fresh, it will likely be a challenge to find a lender willing to take a chance on you. However, here are some credit vehicles where you’re more likely to be approved:
Secured Credit Cards:
A secured credit card is one of the easiest ways to get credit after bankruptcy. For example, a card with a $1,000 limit would require you to put $1,000 down as a deposit in order to be approved. However, it’s likely that you will be approved. These cards have annual fees and high interest rates and you must pay them back like normal credit cards.
By spending and paying off this card, you’re able to build your credit – just make sure that the lender reports your activity to a credit bureau (not all secured cards do).
Co-signed Loans or Cards:
If you have a friend or family member who has good credit history, you can ask them to co-sign for a loan or credit card. By co-signing, they agree to repay your card or loan if you’re unable to do so. Because the bank is assured that they will be paid back, they will often be more likely to lend to you and offer you a lower rate.
Similar to a secured credit card, secured loans require you to make a deposit or have money in your account in case you cannot repay. These loans are mostly offered by credit unions and community banks. They also allow you to make regular payments that improve your credit.
Another way to boost your score is to be added to a friend or family member’s credit card as an authorized user. It’s best to do this with a card that they have held in good standing for a very long time. Their account will be added to your credit history, helping you benefit from their good credit behaviour by giving your score a boost.
Use Credit Responsibly
Once you get a new credit account, it’s critical that you use it responsibly. This entails paying off all credit card balances at the end of the month right on time and only spending within 20%-30% of the card’s limit. One of the ways your credit score is calculated is by looking at your credit utilization, so if your credit limit is $1,000, you should only spend $200-$300 each month. If you use too high a percentage of your available credit – even if you pay it off on time and in full every month – credit bureaus will assume that you are still facing financial difficulties. If you must put more than that amount on your card in a certain month, make sure you pay off the balance mid-month and charge more afterwards.
After you’ve been building your credit for about a year, you can start applying for unsecured loans or credit cards. At that point, lenders might be more willing to work with you. However, don’t apply for too many as that will negatively impact your score.
The Final Word
While it isn’t easy to build your credit after bankruptcy, you will see a gradual improvement in your score if you pick up the pieces as soon as possible. Once your bankruptcy is off your record in up to 7 years, you will be considered like any other borrower. If you’ve spent time building your score over those years, you should be able to qualify for better interest rates and other types of loans or credit.
This is the 2nd edition of Amanda Reaume's monthly "How to Build Your Credit Score" series.