Credit after bankruptcy: what you need to know

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caution sign   bankruptcy ahead

When you've been made bankrupt, life changes dramatically overnight. You usually lose your house, your car, your savings, your disposable income, and any sense of financial freedom. Some people may even lose their job. Even after the bankruptcy process is over 12 months later, you'll struggle to get a credit card or a mortgage.

But there are some positive steps you can take to improve your position.

What happens?

Bankruptcy has one big advantage - all of your unsecured debts are wiped out after one year. This includes credit cards, store cards, overdrafts, utility bill arrears, mobile phone contracts, catalogue debt, and any kind of unsecured loan. So people you owe money to will no longer be able to chase you for your debts. It won't write off your mortgage or any hire purchase agreements.

However, aside from the potential impact on your life and your job, there's a huge price to pay for this benefit. Your case will usually be passed to the official receiver or an insolvency practitioner (acting as a trustee) - who will take everything you have of value (which it does not consider to be essential).

If you have any assets at all - including any equity in your home, a car or any savings or investments, these will be included in the bankruptcy and you'll lose them. You need to hand your trustee your bank cards, cheque books and credit cards too.

You cannot escape this by giving your assets to friends or family - because anything you have given away or sold for less than its true value for the five years running up to bankruptcy can be reversed and included with your assets.

Your bank account will usually be closed too, as at the moment banks don't like the potential liabilities they have by letting a bankrupt operate even a basic bank account. Your accounts will be frozen, although your trustee will let you have money you need for emergencies - such as to buy food.

In most cases your pension will not be affected. However, if you are at retirement - or very close to it - you should seek advice before considering bankruptcy as it could hit your pension pot.

During the 12 months of the process your trustee will decide whether you have to make payments from your spare income too. This will usually happen if your assets weren't enough to cover your debts, and the trustee calculates that after receiving your pay and covering the essentials, you have any spare cash.

During bankruptcy

During the bankruptcy period, if you want to apply for credit of more than £500, you are legally obliged to tell the lender you are bankrupt - which will make it incredibly difficult to borrow money. This period is one for working to pay off whatever you can, so arguably it's not time to rebuild just yet anyway.

You may even struggle to get a bank account. At the moment only one mainstream bank, Barclays, will offer a basic bank account to bankrupts. This is because banks are concerned that a trustee in bankruptcy could claim compensation from the banks, if money has passed through a bankrupt's account.

Rebuilding

After the 12 months have passed, your bankruptcy will stay on your credit record for another five years. During that time, many lenders will refuse to lend to you, because they have a policy of not lending to people who have been made bankrupt. Those who are still willing to lend may charge a higher interest rate because they consider you more of a risk.

Even after the six years have passed, some lenders (particularly mortgage lenders) will ask whether you have ever been made bankrupt, which means that they will never lend to you - no matter how much time has passed.

What can you do?

However, this doesn't mean you cannot take positive steps to improve your credit rating. The first step is to get hold of your credit report, from an organisation like Experian, and check that it shows that the bankruptcy has been discharged, so that lenders know you're not still in the 12 month period.

You should also check that the debts included in the bankruptcy have been updated to show that there is no outstanding balance showing. If there is a mistake you can raise it with Experian, who will correct this with the lenders.

You can also add a 200 word explanation to your report if there were extenuating circumstances surrounding your bankruptcy which would reassure a lender that it is unlikely to happen again.

According to Experian, the next step for many people should be to obtain credit. You are likely to have to go to a specialist who deals with people who have damaged credit ratings, and you are likely to face sky-high interest rates. It may seem counter-intuitive to do this. You may be worried about borrowing any money given that this was how you got into trouble last time, and high interest rates may bring back difficult memories too.

However, there is a very sound reason for doing this. If you borrow regularly and show you can manage repayments sensibly, you will be building up a record of sensible money-management. By the end of the six years, the bankruptcy will disappear and all that will remain on your record is sensible borrowing. If you don't borrow anything at all during this time, at the end of the period you'll be left with an empty credit record - which lenders don't like.

Once you have had a few months of sensibly managing your credit repayments, you can add a mobile phone contract, which will show on your credit record and demonstrate that you can reliably pay bills too.

Of course, this comes with a two huge caveats. If you are unable to borrow sensibly, and cannot stop yourself from living beyond your means, then you should steer clear of any kind of borrowing or credit, and seek help. You'll need to develop a more sensible approach to money before any kind of rebuilding is possible.

And if you decide you can borrow sensibly, then you have to stick with this rigidly. You mustn't borrow more than you can afford, and you need to pay off in full and in time every month. That way you avoid interest charges, and your borrowing doesn't risk getting out of control. After-all, it's pointless borrowing in order to repair your credit rating if it just ends up damaging it further.