How to Recover from a Bankruptcy in X Steps
Bankruptcy has a huge effect on your life, but you can recover from it if you follow the right steps.
Image source: Getty Images.
If you've reached the point where you're unable to pay your debts, then you may have decided that filing for bankruptcy is what you need to do. It's a lengthy process that causes quite a bit of damage to your credit, but sometimes consumers have no other options.
While there's no avoiding the impact of bankruptcy, the steps you take in the aftermath will determine how long your bankruptcy affects your life.
1. Assess what went wrong
There's always an underlying reason when a person declares bankruptcy. To avoid experiencing the same issues in the future, you need to figure out where things went wrong.
Here are some of the most common reasons for declaring bankruptcy and how you can avoid them:
- Medical debt: This is one of the most common reasons that adults in the United States file for bankruptcy, and that's why it's important to have health insurance coverage. It's also a good idea to start an emergency fund for this kind of situation.
- Credit cards: If you accumulated too much credit card debt, then you'll need to reevaluate your budget and never charge more to your credit card than you can pay off in a single billing cycle.
- Reduction or loss of income: Losing your income is always a major challenge to overcome, but an emergency fund can at least tide you over until you get back on your feet. You should also aim to keep your essential expenses to 50% or less of your income. That way you won't need to go into debt if your income drops.
2. Build a better budget
Bankruptcy is often a sign that you were either spending too much or not saving enough, although in some cases, it can also be a case of plain-old bad luck. Either way, you'll need to reevaluate your budget so that you can avoid future financial troubles.
Go over all the monthly expenses you expect to have and compare them to your income. If you filed for Chapter 13 bankruptcy, make sure you include your debt payment plan into your calculations.
A smart goal is to have enough income that you can save at least 20% of it and pay any expenses (including the necessities and the things you want) with the rest. If you can't do that, then you should look for ways to pare your expenses or earn more income.
3. Get a secured credit card
The best way to rebuild your credit is by using a credit card, but card issuers almost always cancel your cards with them when you file for bankruptcy, and it's tough to get approved for a new card after a bankruptcy.
Secured credit cards are a notable exception, as they're available to consumers with bad credit. While you must pay a security deposit to get a secured credit card, many of the best secured credit cards allow you to graduate to an unsecured version of the card and get your deposit back after making enough on-time payments.
After you get a credit card, use it for at least one purchase per month, and then pay off the entire balance by the due date.
4. Never miss a bill payment
The only way to rebuild your credit is to put together a history of on-time bill payments. Any missed payments will bring you back to square one, so it's imperative that you pay every bill on or before its due date.
There are plenty of ways you can ensure you make your payments on-time, such as setting up auto-pay or subscribing to alerts when your payment is due.
5. Don't borrow money
It's a bad idea to take on new debt when you're recovering from a bankruptcy. You'll have another bill to pay, and when you have a low credit score, odds are you'll need to pay a sky-high interest rate any time you borrow money.
Even putting aside how much you'd pay in interest to borrow money, you should get into the habit of only spending money you currently have.
6. Start saving up an emergency fund
One reason consumers end up in debt and eventually declaring bankruptcy is because they had an unexpected bill or loss of income that they weren't prepared for. That's why you need to have an emergency fund with enough money saved to cover a big expense or tide you over during a job loss.
Financial experts recommend you have an emergency fund with three to six months of living expenses. That may seem like a lot, but you don't need to save that much overnight. Just start putting as much money aside as you can per month. Even $100 or $200 every month adds up and will leave you better prepared for an emergency.
7. Keep an eye on your credit
If you follow the steps above, your credit will gradually recover from the bankruptcy, but you should also monitor it. Here's how:
- Request your free credit reports from Equifax, Experian, and TransUnion every year to check for errors. The fastest way to do this is through AnnualCreditReport.com.
- Sign up for a credit monitoring service to receive alerts regarding any changes on your credit file or to your credit score. Some of the top bank accounts offer this as a complimentary perk, so be sure to check if yours does.
By taking these steps, you'll be able to verify that there aren't any mistakes on your credit file, and you can make sure your credit score is steadily improving. Eventually, your bankruptcy will drop off your credit file and stop affecting your credit. This happens in seven years with Chapter 13 bankruptcies and 10 years with Chapter 7 bankruptcies.
Bouncing back from bankruptcy
A bankruptcy isn't something you can recover from in a matter of weeks or months, but you can make consistent progress with the right approach. If you're willing to put in the work, you can end up in a better financial situation than before and even get a credit score that's just as good as, or better than, the one you had.