Is There Life After Bankruptcy?
YOUR CREDIT SCORE BEFORE AND AFTER BANKRUPTCY, AND THE PROSPECTS OF RECEIVING CREDIT AFTER BANKRUPTCY
Many people have the idea that after filing bankruptcy, their credit is ruined forever and they can never have a decent credit score again. This is not guaranteed to be true. Whether it happens depends entirely on you.
Even if you vow to never use credit again after filing bankruptcy, you need a good credit score. More and more auto insurance, health insurance, and life insurance providers are taking your overall credit score into account in deciding how much to charge you! You can save yourself a bundle by guarding your credit score, even if you never use a credit card again.
To intelligently plan your credit future after bankruptcy, you need to understand a little about how credit scores usually work. There are three main credit bureaus: Equifax, Experian, and Transunion. Each of these gives you a credit score, which are usually different though not far apart. You (or prospective creditors) can also obtain a single score which takes all three bureaus into account.
WHAT DETERMINES YOUR CREDIT SCORE
There are many factors which go into determining your credit score. The bureaus are very secretive about exactly what formulae they use (called “algorithms”) to guard against people attempting to manipulate their score. Although no one outside these bureaus knows exactly what is in each algorithm, through years of observation, watchers of the credit industry have learned some general principles of how they determine your score.
GENERAL FACTORS
First, there are some general factors. Do you own or rent? How long have you lived at the same address? (Someone who has had five addresses in three years is generally assumed to be less reliable than someone who has had the same address for fifteen years.) How high a percentage of your income is taken up by your mortgage? A mortgage payment that is 60% of your income will count against you; one that is 25% of your income will not. Likewise, how long have you had the same job? And, very important: How close are you to your borrowing limit on each account? Generally speaking, it is best to borrow no more than 15% to 25% of your borrowing limit on each account. Maxed-out accounts count significantly against you. There are many other factors, but this gives you an idea.
THE BAD NEWS
Next, each month that you are reported as paying late (or not paying at all) on an individual account brings your score down some. For example, if you are late in paying on two revolving charge accounts, and pay on four others on time, it will bring your score down some. If you do not pay on three accounts at all, but pay on three others on time, it will bring your score down more. If you do not pay on six accounts at all, it will bring your score down a lot more. Most credit cards, etc. report every month to all three collection agencies as to whether you are up to date or not. Each and every month you are late or do not pay stays on your permanent credit record for seven years after it is first reported (a separate black mark for each month, for each account). After seven years, it comes off the record. So, if you get behind on an account and stop paying for three consecutive months, seven years later one negative report will come off your report for each of three months in a row. (Most medical bills are not reported to the credit bureaus until they reach the next stage, below.)
Third, any collection efforts are even worse on your score. If a creditor sends a bill off to a collection agency, that hurts your score a lot. So does each successful collection effort – being sued hurts your score more, and so does losing the suit or getting a default judgment against you. A resulting garnishment or lien to attempt to collect on a judgment brings your score even lower. All three credit bureaus check all courts at least once every three months, and record each of these “public record” events. Again, each of these stays on your permanent credit record for seven years after it is first reported. After seven years, it must come off the record.
Finally, major negative events hurt your credit most of all. Foreclosure on your home or other real property, repossession of a vehicle, or bankruptcy each cause a major decrease in your score. (A “deed in lieu of foreclosure” or “short sale” also counts as a major negative event.) Also, a Chapter 7 bankruptcy can stay on your record for ten years (Chapter 13’s stay seven years). But it should be noted that Chapter 13 bankruptcy does not hurt your credit as badly as Chapter 7 bankruptcy. So much for all the bad news.
THE GOOD NEWS (SUCH AS IT IS)
But it’s not as depressing as it sounds. A negative mark – whether relatively minor, such as a missed credit card payment, or major, such as a foreclosure – may stay on your record for seven years (Chapter 7 bankruptcy stays for ten years), but how much it counts against your credit score decreases every year. So, a three-year-old negative report does not count nearly as much against you as a similar one-year-old negative report; a six-year-old negative report does not count nearly as much against you as a similar four-year-old negative report; and so forth.
Also, accounts paid promptly build your score up every month. Just as every month an account that is late counts against you, so every month it is paid on time counts in your favor, though one negative mark can wipe out many good marks.
WHAT GOOD THIS KNOWLEDGE CAN DO YOU
Many just throw up their hands and say, “What’s the use – my credit is already ruined for years.” But this is exactly the wrong way to look at things. There are at least two lessons you can take away from this discussion:
1. STOP THE HEMORRHAGING AND RESCUE YOUR CREDIT SCORE AS MUCH AS POSSIBLE.
When someone has had a major accident, before you can treat the wound or give antibiotics or a vitamin shot, you must stop major bleeding first. Likewise, when you are in financial trouble, you need to stop the major inevitable decreases in your credit score.
ONE WAY OF HANDLING THINGS
Ironically, people of conscience who try the hardest to pay their bills can make their situation far worse, in terms of their credit recovering. They may keep trying to stay afloat long after their circumstances make declining credit inevitable. For example, though a family may have good credit up until now, a layoff, a cutback on work hours, or a major injury or stroke may cut their income to the point that they cannot pay all their bills. Once this is clear, they may make an awful choice: thinking they are “doing the right thing,” they can “try to hold on and pay everything” even though the facts clearly show that they do not have enough income. As a result, the collection calls and letters start coming in. They rationalize their decision by saying, “Maybe things will get better.” But they rarely do. So they borrow against their life insurance, drain their savings, then drain their 401(k). The collection calls and letters get worse and worse, and their formerly peaceful home life is turned into a never-ending blizzard of stress, arguments about money, and despair. Their credit cards get 30 days overdue, then 60, then 90. Their creditors cut off their accounts and turn them over to collection agencies. They get warnings of lawsuits, maybe even foreclosure; then the next thing you know, they get court judgments against them, garnishment of their bank accounts and salaries, liens, unrelenting collection calls from others, and so on. Finally, they “see the light,” and realize that bankruptcy is the best way out, and reluctantly go see a bankruptcy attorney. But by then, they may have many months of not paying their accounts on their credit record, not to mention several court judgments, garnishments, liens, maybe a repossession or two, or even a foreclosure. All of these depress their credit score much lower than if they had filed bankruptcy earlier. Hence, it takes them much longer to rebuild a decent credit score coming out of bankruptcy.
A BETTER WAY
Let us assume that the family with decent credit which had its income cut to the point that they can no longer pay all their bills takes a long, hard look into the future. They see that with the income cut, starting this month there is no way they can pay all their bills on time, so they promptly go see a good bankruptcy attorney. They file bankruptcy. Immediately, all lawsuits, garnishments, foreclosure, and repossessions are stopped. The negative credit reporting ceases. If they file Chapter 7 and have kept up with their mortgage payments and do not have over $43,000 equity (Georgia limits) in their house, there is no foreclosure. If they have not kept up their mortgage, and/or they have more than $43,000 equity in their house, perhaps they can file Chapter 13 and keep their house, if they have at least one income. Either way, when the bankruptcy is over, they start over with a clean slate. They do not have many months of slow or no payment on their credit report; no court judgments, no garnishments, no repossessions, no foreclosure; and they avoided many rattling months of stressful calls and letters from collection agencies, which would have made them hesitate to answer their phone or even look at their mail. True, they have a major hit against their credit – the bankruptcy. But because they filed bankruptcy promptly, before their credit score began a major inevitable, irreversible decline, their overall credit score is not depressed nearly as much, and as a result their recovery is much quicker.
2. THERE IS LIGHT AT THE END OF THE TUNNEL.
After your bankruptcy (wherever your credit score ends up) make absolutely sure you never abuse credit again. Pay every bill promptly, and if you do not have cash, do not buy it. If you were careless before the bankruptcy, learn from your mistakes.
Believe it or not, most people coming out of bankruptcy receive offers of new credit cards. Why? Very simple: 1) They carry high to very high interest rates; and 2) the lenders know you can’t file bankruptcy and get a discharge again for eight years.
If you are certain you have the self-discipline to control your use of credit absolutely, go ahead and take a couple of the best of these credit card offers – not so you can go on spending yourself into trouble, but rather so you can begin rebuilding your credit. Here’s how:
With one of these new cards, buy all your gasoline regularly, and nothing else. Then pay the balance in full promptly most months, a few days before it is due, using the money you would have used for gas anyway. Do not pay the balance in full every single month; every few months just pay the minimum balance for a month or two, then pay it all off the following month. Even at a high interest rate, this will not amount to much extra. This is to make sure they do not cancel the credit card due to never making any money off you. By doing this, you will create a good regular payment record, and your credit reports will say “pays as agreed” or the like.
With another of the new cards, only buy the groceries you would ordinarily buy for cash, and promptly pay it, too, every month, paying only the minimum once in a while, then paying it off regularly. Two cards reporting as “paid as agreed” every month, without any more negative reports since the bankruptcy, will gradually bring your credit score up, and the amount the bankruptcy damages your credit will get less and less every month. Regular mortgage payments will also have a powerful effect on your score.
We know of cases where people had good credit but had a major income decline, and then filed bankruptcy promptly before their credit score could decline, and had a credit score in the mid 700’s and were able to buy a house only two years later! Yes, there is light at the end of the tunnel; when you get a fresh start from your bankruptcy, use it wisely. Keep plugging away; pay promptly, use credit wisely to build up your score, and sooner or later, you will be back where you belong. Walt Disney, Donald Trump, and Henry Ford all went bankrupt at one time or another, and they rebuilt their credit. You can too.
ANOTHER WAY TO IMPROVE YOUR CREDIT SCORE
Build up your damaged credit score by making and paying off loans reliably. This loan is not for spending money; it is for building your credit ONLY. (Sounds gimmicky, but it works.) Do NOT do this by going to finance companies and paying high interest rates. One type of loan that can be made easily at a small cost to you is one that uses the money you borrow as collateral. This is done as follows: Get a bank or credit union loan for 6 months or a year. Place the borrowed funds in a savings account at the same bank with the bank placing a hold or lien on the savings account. The interest rate should be very low because the bank has no risk. Even though it may seem like you are paying a monthly payment, most of the money you are paying is going to principal. At the end of the loan term, you use the savings account to pay off the loan, resulting in a paid as agreed, paid off loan on your credit report. Since most of the payment was paid to principal, you will have almost as much money in your savings account when the loan is paid off as you paid in loan payments over the 6 months.