Step Three: Re-Establishing Good Credit

Information from your credit report is used to calculate your credit score. Your credit score is the single most important factor lenders use to decide whether or not to give you a loan, and how much to charge you in interest and other fees.

Do I have to have debt to have a credit report? Unfortunately, with the traditional CRAs, the answer is "yes." In order to have a traditional credit score and something other than a "blank" or non-existent credit report, you must have credit accounts. Credit reporting is purely voluntary: lenders are not required to report your payments and the CRAs are not required to report them either, both are just prohibited from reporting false information.

The three traditional CRAs usually do not report your on-time payments for things like rent and utilities. There is an "alternative" Credit Reporting Agency called PRBC** (Payment Reporting Builds Credit, see www.prbc.com). PRBC allows you to pay utilities and/or rent through their on-line bill payment and then keeps a record of your on-time payments. There is a small monthly fee for this service, but the fee is not as much as you would pay in interest for a loan each month. Although PRBC is not widely used by lenders, you can ask your lender to request your report from them.

All credit is not considered equal. For the purpose of your credit score, some credit is more valuable than others. Real estate loans (mortgages), vehicle loans or unsecured loans are all considered very good forms of credit. A high-interest loan from a finance company, a store charge account or a collection account may actually have a negative impact on your credit score. See "credit score negatives" to learn more. Having two types of credit will help to increase your credit score more quickly. "Installment loans" include any student loans, automobile loans, or signature loans. "Revolving credit" includes credit cards or home equity lines of credit.

Think local. If you are not a member of a credit union see if you can join one. If you can develop a relationship with a local credit union or a smaller local bank, you should be able to get an appointment to explain your situation to a personal banking representative. Honestly tell this banker why or how you got into financial trouble or had to file a bankruptcy. Tell the banker why you are in stable financial condition now and how you want to rebuild. Then, ask if the credit union or bank will consider making you a small, unsecured loan, for example, $2,000 for one year. Offer to put the $2,000 loan proceeds into a savings account with that same credit union or bank and simply use this account to make your monthly payments on time until the loan is paid if the credit union or bank will report your payments to the CRAs. You will still have to pay the extra interest from your own pocket, but if you don't spend any of the loan amount, this will be a small price to establish an excellent credit line on your credit report.

Credit Cards. Many people file bankruptcy in part because of credit card debt. Naturally, you do not want to get in debt again! The correct way to use credit cards is only for the convenience of not having to carry cash and to get rewards. This means that you pay off your balance in full, on time, every single month. In other words, never charge something that you don't have the money to pay for. Be honest with yourself. Credit cards are not for everyone. If you don't trust yourself to use a credit card in this way, it's best not to have any. But be aware that most debit cards do carry higher risks if lost or stolen.

Most people who have filed bankruptcy get many credit card offers mailed to them after their bankruptcy. These credit cards often carry high interest rates or "fine print" with unpleasant terms, but so long as you pay your bill on time, in full each month, these things won't matter. When obtaining a credit card, you may wish to avoid companies whose policy is to not report credit limits and use your most recent balance instead, such as Capitol One and American Express. Using credit cards and making on-time payments without using too much of your available balance is one way to build good credit on your credit report. Some people find it helpful to use a credit card only for a particular expense category (food, gasoline, etc.) to help them track their spending in that category.

If you cannot get a regular credit card, then you may wish to get a "secured credit card." This is a credit card from a bank where you deposit a sum with the bank to "secure," or guarantee, the amount of credit that the bank will give you on the card. Since there is no risk to the bank, the bank will not care about any prior credit problems. The credit limits are usually about $200 to $500. With on-time payments the institution will often raise your credit limit without asking for a larger deposit. But read all the terms because some secured credit card offers can be misleading, such as limiting your purchases only to items from a certain catalogue.

Renting after bankruptcy. Be persistent and pro-active. Often if you tell people your situation up front, they will give you a chance. If the bankruptcy relieved you of your debts to the point where you are well able to afford the rent payments, you should be a good risk to a landlord. Explain this to them.

I really want to get a house and a mortgage. This is a common goal and a good one. But it's also the biggest, most important purchase most people ever make, so don't rush it! If apartment living is not for you, look for a home, condo, or town home to rent; you can often find one for rent by an owner. Can you get a mortgage within a year or less of bankruptcy? Probably, yes, but usually with terrible terms that may cause you financial hardship and heartache in the future! The better choice is to wait to get a home when you can make a down payment and qualify for a low interest, fixed-rate, standard mortgage. The difference between rushing it and waiting may not only be hundreds of dollars a month but also thousands of dollars over the course of the loan. Hybrid mortgage products can lead to disaster. Finally, be sure you realize all the costs of homeownership before you buy. There's not just the principal and interest on the mortgage, but the money for real estate taxes, required homeowner's insurance, maintenance of the home, etc. If you must get a mortgage sooner, look for a fixed rate mortgage with no pre-payment penalties and no odd terms. Then you can try to refinance in a few years when you've rebuilt your credit more. See "Home Buying Tips" coming soon from Hummingbird.

Co-Signers. If someone else is willing to put his or her credit and finances on the line for you, a co-signer with good credit can really help you to get better credit terms. On the other hand, you should know that merely being an "authorized user" on someone else's account doesn't really help your credit.