You'll likely have to give up all of your credit cards if you file for Chapter 7 bankruptcy, but you can start rebuilding your credit once your case is closed.
If you file for Chapter 7 bankruptcy and are hoping to hang onto one of your credit cards, you will likely be out of luck. Once your credit card company learns of your bankruptcy, it will almost certainly cancel your card. But all is not lost. Read on to find out more about why you cannot keep credit cards when you file for bankruptcy and what you can do to get another one later on.
Why a Credit Card Company Will Cancel Your Card When You File for Bankruptcy
When preparing to file for bankruptcy, it is common for a potential filer to want to "exclude" a particular debt from the bankruptcy petition, such as a credit card used for work expenses or a beloved pet's medical expenses. No matter how important the card might be, excluding debt is not an option when you file for Chapter 7 bankruptcy. Bankruptcy law requires you to list all of your debt on your bankruptcy petition, without exception. In other words, if you owe a creditor money, the creditor must appear on your petition.
This rule, however, goes a step further. Even if you don't owe a balance on your credit card, you must still list it in your bankruptcy papers. A revolving credit card account is a type of contract, and your contracts are automatically canceled by bankruptcy, including credit cards, leases, and secured auto loans, to name a few. As a result, once your credit card company finds out about the bankruptcy and realizes that it no longer has a contract, it will cancel your card because it won't be able to enforce any ongoing obligations. Simply put, without a valid agreement in place, the credit card company will not be able to make you pay for your purchases.
(Learn more about what information you must include in your bankruptcy papers.)
Why You'll Be Offered Credit After Bankruptcy
Even though you lose your cards during bankruptcy, you'll still be able to obtain a credit card or other consumer financing—and possibly sooner than you might think. Once the Chapter 7 bankruptcy closes, you will be free to start rebuilding your credit. In fact, many people receive new credit card offers in the mail within months of receiving their Chapter 7 discharge.
While this might seem surprising, it will make sense once you understand why credit card companies will consider you a good risk. Here's why:
- Bankruptcy wipes out all of your credit card debt, so you have more discretionary income to pay bills.
- Most people use credit cautiously after bankruptcy because they don't want to find themselves in the same predicament (and tend to refrain from using credit for frivolous purchases).
- The credit card company knows that you can't file for Chapter 7 bankruptcy for another eight years, and so there is lots of time to collect against you, if necessary.
Of course getting a credit card soon after bankruptcy is not a wise choice for everyone. You are in the best position to decide what will work for you. (To learn about the pros and cons of jumping back into the credit treadmill, see Should I Get a Credit Card After Bankruptcy?)
How to Rebuild Your Credit After Bankruptcy
The credit reporting bureaus reward people who can responsibly handle the mix of credit that most households maintain, which includes one or two unsecured credit cards, a car loan, and a secured credit account, such as a furniture or jewelry store card. Car loans, furniture accounts, and jewelry store cards are "secured" accounts because you must promise to give back the merchandise if you fail to make your payments. Once you have the right mix of credit, of the utmost importance, of course, is making timely payments.
Each month, you'll want to pay your balances down to 10% to 30% of your available credit—but not pay off the card. Paying off your entire balance triggers the credit card company to pull your credit, and every time that happens, your credit takes a hit.
There is another reason why it's not a good idea to use more than 30% of your available credit: The amount of credit available on your account strongly influences your credit score. For instance, your credit score will be much higher if you have $3,000 in available credit as compared to only $300.
Plus, a heftier amount of available credit will allow you to use your card for your everyday purchases, such as groceries and utility bills—and doing so is an important part of rebuilding your credit. When you use your card regularly and pay it down, but not off, each month, you put a lot of money in the credit card company's coffers, because each time you use it, the store must pay the credit card company a percentage of your purchase. Credit card companies like it when you make money for them, and, as a result, the credit card company will likely increase your credit line in a surprisingly quick manner to encourage you to keep making the company money.
This same rationale will help you understand why it is not a good idea to open cards with small limits. A credit line of $500 can hurt your score because you'll never have much available credit. In other words, hold out for cards with a larger credit limit. If you follow the technique outlined above, your credit line will likely increase, and, as it does, your available credit will follow, the effect of which will be to drive up your credit score.
(To learn about ways to rebuild credit, see Tips to Repair Your Credit After Bankruptcy.)
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