CardRatings.com’s Curtis Arnold has compiled a list of what he believes are the best credit cards Americans can have after a bankruptcy. While I’m not really all that interested in how all these cards compare to one another, I’d like to say a few words about the concept of extending credit to a person whose bankruptcy has been recently discharged.
At first glance, giving a credit card to someone who’s just been released from the obligation to repay his previous debts sounds like an extremely risky proposition, doesn’t it? So why would any lender do it? Arnold’s explanation is that “[l]enders understand that a bankruptcy rarely reflects your true relationship with money” and he cites a survey, which has found that about 80 percent of all bankruptcies are the result of events over which the debtors have no control. Well, that may all be true, but there is a much more compelling reason for the issuers’ willingness to lend to people with recent bankruptcies on file. It is that you cannot file for another bankruptcy, and so default on your new credit lines, for several years after your latest discharge. Let’s go over the details.
Chapter 7 vs. Chapter 13
There are no limits on how many times you can file for bankruptcy in the U.S., but there are rules on how often you can do it. These are federal rules, so they apply to all states, and the law differentiates between bankruptcies discharged under Chapter 7 (liquidation) and Chapter 13 (reorganization) of the bankruptcy code.
If you have had your debts discharged under Chapter 7, you must wait for eight years before you can file another bankruptcy Chapter 7 petition or four years if you are filing for Chapter 13 protection. If, on the other hand, your debts have been discharged under Chapter 13, you must wait for six years before you can file for Chapter 7 and only two years for another Chapter 13. The time limit does not apply if you are filing for bankruptcy under Chapter 7, having repaid 70 percent or more of your unsecured debt (which includes credit cards) during your previous Chapter 13 reorganization procedure.
The reason the law is more lenient toward Chapter 13 filers is that they commit to making an effort to pay back at least some of their unsecured debt, under a court-approved plan, which is not the case in Chapter 7.
Credit after Bankruptcy
Now you can understand why creditors are willing to lend to the recently bankrupt. Of course, these are still considered very risky loans, which is why they are extended on rather unattractive terms. After all, the debtor may not be able to file for bankruptcy anytime soon, but he is still statistically more likely than the average one to not pay it back. And if that is the case, there is not much the lender can do. Yes, in theory, the debtor could be sued, but in practice the lender would be unlikely to do it, simply because the potential return, if any, would be outweighed by the cost of the legal proceedings.
The types of credit cards that are available to the recently bankrupt typically feature a low credit limit, charge an annual fee and a high interest rate and require a security deposit. It is not the type of card that someone with an average credit score would ever consider.
And yet, unappealing as these cards may be, they still represent the best card option that is available to the recently bankrupt, easily beating out debit and prepaid cards. The reason is that only credit card use affects your credit score and improving it should be your top priority. Over time, if you consistently make your payments on time, you will start receiving offers for more typical credit cards and you should accept one of them. Until then, however, you shouldn’t be actively applying for one of these “normal” credit cards, because you will be rejected every time and each one of these applications will be listed on your credit file, which counts against you.
Arnold’s counsel is that “[g]etting back into debt shouldn’t be your goal when applying for credit cards after bankruptcy.” I find that advice slightly disturbing. Should getting into credit card debt ever be anyone’s goal? Does anyone really need to be told that this is a bad idea and it should be avoided? Fortunately, recent data indicate that a vast majority of American credit card users are answering these two questions in the negative. Both credit card charge-off and late payment rates are at historic lows, and early-stage delinquencies are at 0.75 percent. So I’m hopeful!
Image credit: FreshersTalk.com.