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REBUILDING YOUR CREDIT AFTER A PERSONAL BANKRUPTCY

The importance of good credit in our economy cannot be understated.  It is a factor to be considered not only in lending, but also in the acquisition of housing, employment and higher education.  The effect of a personal bankruptcy on a consumer’s credit is usually one of the primary concerns that we encounter in our daily practice, as we meet with financially-strapped consumers.  This article will seek to address those concerns, and hopefully provide some guidelines on how credit can be re-established following a discharge in bankruptcy.

As a practical matter, the credit score of consumers who are in the process of filing for bankruptcy is usually pretty low already.  The factors that motivate most bankruptcy filings – lawsuits, garnishments, foreclosures, and repossessions – will also significantly impair your credit.  Many times the damage to one’s credit has already been done long before they darken the door of a bankruptcy attorney’s office.  As a result, the eventual filing of a bankruptcy case will have negligible result on a consumer’s overall credit score.  However, the peace of mind (and peace and quiet) that comes with the elimination of the problematic effects will probably far outweigh any minor downward adjustment in an already low credit score.

In order to rebuild your credit after bankruptcy, it is important to understand that one of the primary factors that lenders consider in evaluating a loan/credit application is risk.  Lenders want to predict the extent of risk of default or non-payment by the consumer, with a calculation of potential losses in the event of such a default.  Surprisingly, a bankruptcy discharge will actually reduce the risk of non-collection for a variety of reasons:

1)      There are restrictions on the amount of time that must pass between bankruptcy filings.  Generally, a consumer cannot receive a bankruptcy discharge if they have received a discharge in a case filed within the previous 8 years.  As a result, lenders do not have worry about the potential discharge of their debt in a subsequent bankruptcy.

2)      Bankruptcy reduces the competition for the consumer’s future earnings.  The average number of creditors in a typical consumer bankruptcy is about 15.  To a potential lender, that represents 15 other creditors with whom they will have to compete in order to get paid.  More “competitors” translates into a higher risk of default.   A consumer who emerges from bankruptcy has discharged those debts and eliminated the competition for a potential lender in the future.

3)      Most legal proceedings such as lawsuits, garnishments or levies will have been eliminated during the bankruptcy, which will enhance the consumer’s ability to make payments to a potential lender.  Consumers who are subject to a lawsuit, judgment or garnishment will face the eventual seizure of a portion of their wages, or any funds held in deposit at a bank or credit union.  Because this increases the risk of default – for instance if your bank account is frozen due to a judgment, all checks written on that account will bounce – it becomes more difficult to obtain financing, if it can be done at all.  By virtue of a discharge in bankruptcy, these avenues of debt collection have been eliminated, alleviating another concern for a potential lender.

4)      Most consumers who emerge from bankruptcy are much more knowledgeable about the cost of credit, and its importance.  This knowledge is derived not only from the experience of having to file a bankruptcy, but also from the court-imposed counseling requirements that consumers must fulfill before – and after – a bankruptcy filing.

With this in mind, what are the best ways to rebuild your credit?  Here are some suggestions:

1)      Save money.  This is probably the most important factor, even though it will not appear on your credit report or factor into your score.  Open a savings account, and arrange for monthly deposit, even if it is as little as $10/month.  I usually recommend a credit union account, as credit unions offer favorable terms to members, and their lending decisions are made locally.  The more money you save, the more you will have available to make a down payment on a house or car loan.  Remember that lenders are always evaluating risk.  The more of your money that you put down, the less they are required to lend, which means that there risk is less.  In addition, by contributing your own money, you are assuming more of the risk yourself.

2)      Don’t apply for credit/loans/financing unless necessary.  Applying for a loan just to pay it off may not assist your credit, and lenders may potentially view it as a warning sign that a bankruptcy filing did not discourage any bad borrowing habits.

3)      Maintain any debts that may have survived your bankruptcy.  Many times certain debts may survive a bankruptcy filing, either by choice of the consumer – such as a mortgage loan on their residence or vehicle loan – or because the law would not allow it to be discharged, such as a student loan.  Paying these debts on time, and eventually paying them off, will go a long way towards re-establishing your credit.

4)      Avoid credit card debt.  While credit cards have become a necessary evil in todays’ economy (try renting a car or booking a flight without one), the accumulation of credit card debt is another potential warning sign to potential lenders.  Credit card companies aggressively solicit consumers who have emerged from bankruptcy for the reasons set forth above.  Do not think that they are doing you a favor.

5)      When applying for credit, always shop around.  Don’t feel the need to accept the terms being offered by an automobile dealership, or the bank that a realtor may have referred you to.  Instead, always try to line up your financing in advance.  Know what your repayment terms are going to be before you shop, and that way you will have a much better understanding of what you can afford.  NEVER be afraid to walk away from closing on a loan, despite the pressure from the seller, if you do not feel that you can afford it.

6)      Maintain stable employment, if possible.   Lenders are repaid through earnings, and the more consistent those earnings are, the less risk of default.

Every bankruptcy case is different, and each lender will use different criteria in evaluating loan applications, and assessing risk.  Don’t be discouraged if you are turned down for a loan, and feel free to question lenders about the reason for credit denials, if they are willing to provide it.  Good Luck!