As experts in debt management, we understand the concerns surrounding bankruptcy and its potential impact on future credit. In this blog, we provide valuable insights and discussion on how a bankruptcy may affect the possibility of obtaining credit in the future. By understanding the implications and taking proactive steps, you can navigate the path to financial recovery with confidence.
Understanding Bankruptcy:
Bankruptcy is a legal process designed to help individuals overwhelmed by debt obtain a fresh financial start. It is a last resort option that provides relief from unmanageable debt by discharging all one’s debts (with some limited exceptions in Canada). While bankruptcy can provide much-needed relief, and it is the option many Canadian make every year, it’s important to be aware of its impact on future credit.
Initial Impact on Credit:
Yes, its true – bankruptcy has a significant impact on your credit report immediately upon filing. (see Understanding Your Credit Score – FCAC Canada) In Canada this means that your credit report will be at the lowest level (R9). The fact that you have been bankrupt will be reflected in your credit report and can lower your credit score during the bankruptcy period.
Even once you complete the bankruptcy, the fact that you have been bankrupt will stay on your credit score for 7 years (generally). But you can increase this score by acting responsibly towards debt which helps to mitigate the negative effects of the bankruptcy.
As soon as you declare bankruptcy, you will no longer have access to any sources of unsecured credit. (like your credit card or line of credit). And so, this means that you will be required to live on a “cash basis” – you can only spend what you bring in each month.
But on the plus side, if you have secured debt (like a house mortgage or vehicle loan) that you can afford, if you continue to make these payments, you can keep your asset. A bankruptcy can help you shed some unsecured debt so you can focus on making payments on the secured debts/assets that you want to keep.
Any ongoing payments you make towards your secured debts will be reported to the credit bureaus during the bankruptcy period – good payment history during this time will positively impact your credit score.
Rebuilding Credit After Bankruptcy – before your bankruptcy is even completed:
a) Secured Credit Cards: One option to begin rebuilding credit is by obtaining a secured credit card. With a secured card, you provide a cash deposit as collateral, which acts as your credit limit. Responsible use and timely payments on a secured credit card can help demonstrate creditworthiness over time.
b) Credit-Builder Loans: Credit-builder loans are specifically designed to help individuals rebuild credit. These loans involve borrowing a small amount, which is held in a bank account or certificate of deposit. Regular payments on the loan contribute to positive credit history.
c) Paying Bills on Time: Consistently paying your bills on time, including rent, utilities, and other monthly expenses, is essential for rebuilding credit. Timely payments demonstrate responsible financial behavior to potential lenders.
d) Responsible Credit Usage: If you are granted credit post-bankruptcy, responsible credit utilization is crucial. Keeping credit card balances low and paying them off in full each month can help rebuild credit over time.
e) Monitoring Credit Reports: Regularly monitoring your credit reports ensures that they accurately reflect your financial progress. Report any discrepancies to the credit bureaus promptly to maintain an accurate credit history.
Timeframe for Credit Recovery:
The big take away is that the impact of bankruptcy on credit is not permanent. While bankruptcy remains on your credit report for several years (typically six to seven years in Canada), its impact lessens over time. By responsibly managing credit and demonstrating positive financial habits, you can rebuild your creditworthiness.
Don’t’ suffer unnecessarily – understand your options now:
Many people struggle for years trying to stay afloat by just making the minimum payments on their debts. This is the ugly truth about credit lenders – they want you to pay forever and ever. People mistakenly believe that they need a good credit score to get through life. This is untrue. A good credit report is necessary to buy assets on credit like a house or vehicle, but it is not necessary for the most part.
But often people tell me they don’t ant to declare bankruptcy because they want to buy a house or a vehicle in the future – Lets look at the reality of these purchasing assumptions.
Buying a home- instead of focusing on your credit score, start by focusing on saving for a down payment (say $30,000). What is the best way to achieve a cash down payment? Getting ride of debt, stop paying monthly interest on revolving debt (like credit cards), increasing your income and reducing your monthly expenses. A bankruptcy can help very quickly with getting rid of personal debt which will allow you to focus on saving a down payment. Once your have saved $30,00, you are guaranteed to have a great credit score because you will have focused your attention everything else key that goes into making a good credit score.
Buying a Vehicle – yes we all need some form of transportation, but no one needs a new car. When I was a young CPA student studying and working at a public accounting firm, I was amused to see that the Tax Partner drove the worst car in the parking lot. (even many of the CA students had nicer vehicles) It was clean, but quite old and beat up. When I asked him why this was, his reply was simple –
“why would I buy something that will immediately depreciate 30% as soon as I drove it off the lot. I paid $3000 for this car and it works perfectly and safely and it costs me less to operate over 12 months than my partner pays in one month for his lease cost”.
He was a smart man.
Think about what you are buying and why. Save up for a vehicle you can afford, take public transportation where available, ride share to work, but don’t borrow money to pay for something that is a pure luxury when something less costly will suffice.
Conclusion:
Bankruptcy does have an initial impact on the possibility of future credit, as it lowers your credit score and stays on your credit report for a significant period. However, it can also be the best way to kick start your savings path and motive you to approach your spending patterns with new perspective. Bankruptcy isn’t free, but at times it can be the best solution with immediate benefits.
After bankruptcy, the key is to use the experience to change your future spending patters. Be responsible for your own financial management. And a bankruptcy can be the first proactive step to rebuilding your credit.
