Is There Life After Bankruptcy?
How to rebuild business credit and get loans after declaring bankruptcy
By Morin Bishop
Declaring bankruptcy is no picnic, and recovering your credit rating after bankruptcy isn’t easy either. But it can be done. Just ask Mike Palladino. The 35 year-old electrician from Quincy, Massachusetts, filed for Chapter 7 bankruptcy in 2002, well before the 2005 bankruptcy law kicked in making it harder for people to discharge debts. Palladino, who ran his own business as a general contractor, was injured when a power tool mangled his hand. Several surgeries and months of recuperation saved the hand, but his business went south, and he ended up maxing out his credit cards to pay for living expenses. “I didn’t want to declare bankruptcy,” he says, “but I really had no choice. There was a long period when just I wasn’t making any money and was up to my neck in bills.”
The bankruptcy discharged Palladino’s credit card balances and many of the debts that he’d run up trying to keep his struggling business afloat, though he still had to pay the IRS for taxes he’d been unable to pay during his illness. But his credit was in tatters and his prospects for rebuilding his contracting business looked bleak. “A contractor works on credit,” he explains. “You need it to buy materials and pay workers and subcontractors it’s hard to do that when no one is willing to let you borrow from them.”Palladino’s problem was one familiar to anyone who has declared bankruptcy. In a time when one’s credit rating is almost a public validation and the gateway to coveted possessions like credit cards, car loans and mortgages a bankruptcy can be like a ghost haunting your credit history and depriving you of the financial means to improve your life.
But even a bankruptcy the ultimate black mark on your credit isn’t an insurmountable obstacle to financial recovery. With apologies to F. Scott Fitzgerald, there are second acts in American life, and most definitely in credit ratings.
Small Steps First:
Pay Every Bill On Time
“You really don’t have any leeway here,” says Jim Shea, a Baltimore based CPA and financial planner. “You are trying to show that your prior financial missteps are firmly behind you and the best way to do that is to meet every obligation utility, cable, cell phone, rent bill, etc. on time.” Not every utility or cable company reports late payments to credit reporting companies, Shea notes, but some do. So there’s no reason to risk anything negative ending up on your credit report.
Shea says that by paying your bills on time you demonstrate a renewed image of responsibility and trustworthiness. Letting bills slide, on the other hand, tells potential lenders that you aren’t serious about financial responsibility or that you may still have financial problems you haven’t addressed. “If you are trying to rebuild your credit, anything that makes you seem still unreliable works against you,” Shea says. “And nothing works harder against you than repeated late payments on your credit report, especially in the wake of a bankruptcy.”
Obtain a Secured Credit Card
You might think that after a bankruptcy particularly one caused by credit debts it would be a good idea to avoid credit altogether. But that would be exactly wrong. In fact, to repair a damaged credit history, you need to replace it with a good credit history. Of course, lenders are naturally wary of extending credit to someone whose credit history suggests the possibility that they won’t be repaid. In order to rebuild your credit, you may have to convince lenders that you can be trusted, and that may require handing over a deposit before credit will be granted.
A secured credit card is a credit account whose limit is backed up by a deposit. That is, you deposit, say $500, at your bank and they provide you with a credit card with a spending limit of $500. In almost all other respects, a secured credit card functions like a normal, unsecured credit card; you can make charges on the card up to the maximum spending limit (usually the amount of the deposit) and you repay the balance, which is subject to interest charges, with periodic (usually monthly) payments. The deposit protects the bank in the event you cannot repay the money charged on the card. In many cases, a secured credit card may be the only line of credit obtainable in the wake of bankruptcy, but if used wisely keeping spending in check and making payments on the card’s balance on time it can help generate a new track record of financial responsibility.
Secured credit cards are good way of creating a new, post bankruptcy history of good creditworthiness, says Gerri Detweiler, author of The Ultimate Credit Handbook, but they often come with strings. “Even though the line of credit is secured by a deposit, you’re still a bad risk in the eyes of the bank, and so secured cards usually come with higher interest rates,” she explains. “So you have to be careful about not incurring penalties like late payments, because the fees and interest payments can eat up a portion of the available credit.”
Detweiler advises shopping around to get the lowest fees and rates on secured cards. It’s also important to make certain that the bank reports the secured credit card’s usage to the major credit reporting bureaus. “Using the card is useless if it doesn’t reflect positively on your credit score,” she says. Since not every bank reports secured card usage, it’s worth asking.
A secured line of credit can be a major step on your path back to creditworthiness. “Generally, people who have a secured credit card say that within seven or eight months they start receiving new offers for unsecured credit cards,” Detweiler says.
Check Your Credit Report
Just because the bankruptcy court cleared your debts doesn’t necessarily mean that they have been expunged from your credit report. According to a recent article in BusinessWeek, in a number of cases some financial institutions failed to report debts that had been discharged by bankruptcy courts to the credit rating firms, even though they are legally required to do so. If the debt is not reported as cancelled by the lending institution, it will remain delinquent on your credit report, potentially sabotaging your efforts to build new credit or obtain life insurance or even employment.
In order to make sure that the bankruptcy court’s orders have been accurately carried out, you should examine your credit report on at least an annual basis. You can obtain a copy of your credit report without charge once every twelve months from each of the three nationwide consumer credit reporting firms (TransUnion, Equifax and Experian). Copies of your credit report can also be requested online (at annualcreditreport.com) or by contacting the credit reporting firms directly.
Credit information (late or missed payments, delinquencies, etc.) remains on your credit report for seven years; a bankruptcy will linger there for ten. Note that the three major firms do not always compare information, meaning that the information on one report may differ from that compiled by a different firm. In order to ensure that all the information in your reports is accurate, you should obtain a report from each of the three firms.
Of course, making sure that bankruptcy debts have been discharged isn’t the only good reason to look at your credit report. Errors in reporting by financial institutions can lead to inaccurate and potentially damaging inaccuracies that can drag your credit down. Taken with the threat of identity theft, checking your credit report periodically is a good idea, regardless of your credit status.
Landing a Loan
Once, a bankruptcy was a nearly insurmountable obstacle to obtaining a loan. Many banks would not even consider lending money to someone until the bankruptcy had cleared from their credit report a ten year wait. “That’s not true anymore,” says Jim Shea. “Banks are much more eager to lend money today and more willing to work around difficulties.” Also, she notes, bankruptcy simply isn’t the damning black mark it once was. “That said, most lenders will want to wait at least a year after the bankruptcy and see some evidence that you’ve put your financial house in order before they even consider a loan,” Shea says. Hence, rebuilding a credit history using secured credit cards will go a long way to helping you get a bank loan.
Even if banks are willing to lend you money after your bankruptcy, those loans will likely come with higher interest rates and fees a reflection of your damaged credit rating. Many banks may request the loan be secured either by collateral a physical asset you own or by a co-signer, someone with good credit who will agree to pay off the loan in the event you default. “Many people find it embarrassing to ask a friend or relative to co-sign a loan for them and it’s a big thing to ask anyone to do but for a lot of people who’ve gone through a bankruptcy, and don’t have many assets left it’s the only way they are going to get a loan,” Shea says.
Building On Success
Once you have begun rebuilding your credit, the best course of action is to stick to it. “It’s really pretty simple,” says Detweiler. “If you have a couple of credit cards and pay them on time along with all your other bills then your credit will recover in time.” Detweiler notes that paying bills early has no effect on credit since only late or missing payments get reported to the credit bureaus. She also recommends keeping purchases small and avoiding carrying balances on the cards while rebuilding credit. “High balances lower your overall credit rating. The goal is to keep the cards active and create a history of on time payment,” she advises. “Just make sure the payment arrives by the due date.”
Massachusetts contractor Mike Palladino followed this advice. He obtained a secured credit card and convinced his brother to co-sign for several loans. “It wasn’t easy and money was really tight for awhile, but within two years, I had my business back up and running,” he says.
Morin Bishop is editor -in- chief of Priority magazine