Bounce back fast after bankruptcy

Most recent bankrupts have trouble qualifying for a regular, unsecured credit card. So the best solution usually is a secured card, which generally gives you a credit limit that's equal to an amount you deposit at the issuing bank.

Typically, that's $200 to $500, which may seem like a pittance compared with the credit limits you enjoyed before your bankruptcy. But don't make the mistake of using your available credit. Maxing out your credit cards hurts your credit score.

You don't want to charge more than 30% or so of your credit limit, and you want to pay the balance off in full each month. Light, regular use of a credit card is what helps build your credit.

And contrary to what you might have heard, you typically don't need to carry a balance or pay credit card interest to build your score, since the leading credit scoring formula doesn't distinguish between balances that are paid off and balances that are carried month to month. Get in the habit now of not charging more than you can pay off every month; your credit score and your finances will be the better for it.

You also shouldn't grab just any secured card. Look for the following:

• No application fee and reasonable annual fee. Some secured cards tack huge upfront and annual charges onto their accounts; you don't need to pay these to build your credit.
• Reports to the major credit bureaus. You're not doing your credit score any good unless your payment history is being reported to the three major bureaus: Equifax, Experian and TransUnion. Before you apply for a card, call and ask if the issuer regularly reports to all three.
• Converts to an unsecured card after 12-18 months of on-time payments. Good behavior should get you upgraded to a regular credit card within a year or two.

Get an installment loan

If you still have student loans (which typically aren't dischargeable in bankruptcy), you can use them to rebuild your score. Make your payments on time, all the time, and try to pay more than you owe whenever possible. Next to making on-time payments, paying down your existing debt is one of the best ways to improve your credit score.

Ken of Chicago took this to heart, making double or triple the minimum payments required to retire his $23,500 student loan debt within three years of his bankruptcy filing.

"The fact that I had to repay my student loans (rather than having them discharged) might have helped me in the long run," he said.

It's unlikely in the current credit climate, but you may be able to qualify for a high-rate mortgage as little as six months after a bankruptcy. You're probably better off waiting until you can qualify for an FHA loan, though. You can typically get one just two years after your bankruptcy case has closed, as long as you've maintained good credit habits since then. FHA loans have interest rates that are usually only half a percentage point higher than regular mortgage rates.

Just make sure you really can afford a home before you buy one. Many people wind up in bankruptcy court because they stretched too far to buy a house and can't keep up with all the attendant costs of homeownership, said bankruptcy expert Elizabeth Warren of Harvard University. (See "Don't bite off too much house" for more details.)

Auto loans can also help you rebuild your credit -- just be prepared to pay nose-bleeding rates at first.

"My first vehicle out of bankruptcy (had an interest rate of) 21%," said Chance Nelson of Indianapolis, who applied for the loan just a few months after his debts were discharged. "After paying this for about two years, I went and traded it in and purchased another (at) 13.99%."

Nelson refinanced this second loan a year later at 7.95%. Five years after his bankruptcy filing, Nelson was paying a reasonable 6% rate for his auto loan.

If you go this route, try to make a big down payment and choose a loan that doesn't have a prepayment penalty. That way, you can refinance the car to a lower interest rate as your credit improves.

Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

Updated Feb. 11, 2009

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