Filing for bankruptcy doesn’t always lead to bad credit, but only if your credit is very bad to begin with.
There are many, many different ways that you can lower your credit score. You can take out too much debt, especially high-interest credit card debt. You can also pay bills late or not pay them at all. And the more frequently that happens, the worse your score gets.
A lot of these behaviors can also lead you to file for bankruptcy. This is a legal process wherein a person (or business) admits that they can’t pay all of their debts. The process allows them to settle those debts with their creditors (aka, the parties to whom they owe money), oftentimes for less than what they actually owe.
However, filing for bankruptcy isn’t all sunshine and debt-free kitty cats. It can mean losing your house, car, or other valuable property. It can also mean having a portion of your income earmarked for debt repayment.
And then there’s what it does to your credit score…
In short, it’s not great.
The only way bankruptcy wouldn’t hurt your score is if high debt load and late payments have hurt it badly already.
Think about it like this: If the kinds of financial problems that cause bad credit are a train ride, then bankruptcy is the final stop on the line.
How bankruptcy affects your score
“Bankruptcy does negatively affect a credit score at first, but less so as time increases from the filing date, says Randall R. Saxton, founder of Saxton Law, PLLC. “However, for individuals who already have negative items on their credit report, the initial drop is not as much as it would be for someone with excellent credit that files a bankruptcy petition, which could range from 160–220 points.”
A drop of 160–220 points could be enough to take you from a great score to a downright bad one.
According to Tracy Becker, President and CEO of North Shore Advisory, Inc, a leading credit restoration, education and monitoring company, the fact that bankruptcy could so drastically lower a high score, “is one reason it is so important for an individual to be aware of their credit scores, so they can make an educated decision before moving forward with a bankruptcy.”
On the other hand, someone whose score is already quite low would have little to lose, credit-wise from filing for bankruptcy.
“Many individuals do not realize that by having many late payments, collections, and defaults, their score may be almost as low as they would be if a bankruptcy occurred,” says Becker.
“Once they find out their credit is already poor they can move forward with the bankruptcy process with an understanding that their scores will not see a tremendous impact.”
When it comes to bankruptcy affecting a person’s score, one overlooked factor is the number of accounts that are included in the filing.
According to Saxo, “An individual who has fewer accounts with amounts owed will have less of a drop than someone with many accounts.”
The different kinds of bankruptcy
Before we moving on, we should talk about the different kinds of bankruptcy.
Chapter 7: This is the simplest and least expensive form of bankruptcy, but that simplicity comes with a price. Under Chapter 7, a person can quickly discharge their debts by surrendering their assets: aka, their car, their house, and other valuables. Those assets are then used to compensate creditors.
Chapter 13: Under this form of bankruptcy, a person repays all or part of their debts according to a repayment plan—a plan that cannot last longer than five years. The bankruptcy court must approve the repayment plan before it begins, and the debtor actually makes their payments directly to the court, who then pays the creditors in return. In order to qualify for Chapter 13, a debtor must meet certain income and debt-load requirements.
Chapter 11: This is a form of bankruptcy that’s most commonly used by corporations and businesses. However, it can be used by individuals as well. Chapter 11 involves a restructuring and reorganization of a person’s debt and assets. It is much more complicated—and thus much more expensive—than either Chapter 7 or Chapter 13. It can allow for a debtor to repay their creditors over time according to a court-approved repayment plan and can be a good option for someone who does not qualify for Chapter 13.
When it comes to your credit score, the main difference between these Chapters 11, 7 and 13 comes down to how long they will affect your score.
How long does a bankruptcy hurt your score?
“All personal bankruptcy types have a major impact on scores (unless they are already poor). Some bankruptcies remain on credit for seven years while others remain for ten,” says Becker.
All the accounts that are included in the bankruptcy are marked as such on a credit report. They do not disappear once the bankruptcy is finalized and they can remain for seven years. Every year from the date of the original delinquency (bankruptcy) scores will improve but not dramatically.
“Usually after the first 5–6 years from the bankruptcy, credit scores are impacted minimally,” she says.
But when it comes to just how long a bankruptcy can affect your credit, the type of bankruptcy filing does make a difference.
According to Becker, “Chapters 7 and 11 remain on a person’s credit report for ten years, regardless of whether it was discharged or dismissed.” She also says that Chapter 13 bankruptcies “can remain on file for ten years from the date filed but, if discharged, will remain on file for seven years from the date filed.”
“Debts remain active during a Chapter 13 bankruptcy plan, which lasts between three and five years,” says Saxton.
“Thus, the removal of discharged debts from the credit report which occurs after seven years can take three to five years longer for a Chapter 13 bankruptcy than a Chapter 7 bankruptcy.”
However, while the effect on your score might become minimal, the bankruptcy filing itself still remains on your credit report.
After seven years, items such as debts, judgments, and foreclosures that were discharged by the bankruptcy are removed. However, the record that a bankruptcy was filed remains on the credit report for ten years,” says Saxton.
This means that a lender who pulls your credit report during a loan application might still be wary of lending to you—or might insist on raising your interest rates—even if your credit score has recovered.
How can you improve your score post-bankruptcy?
“To improve your credit after a bankruptcy a person can apply for specific cards that gear towards those with poor or no credit,” says Becker. “These cards are “secured credit cards”. It’s important to make sure the credit issuer reports the history to the credit bureaus.”
“Once they gain approval they need to use the card responsibly. After using the card for a year they can check their scores and see how they have increased. At that point, they may have access to approvals on better non-secured cards. They can build upon their responsible use of the new credit and time passing. At the third year seeking out a highly qualified credit expert for advice on credit improvement can also help boost the scores prior to the five or six year wait,” she says.
“If consumers file for bankruptcy due to mismanagement of finances they should learn from the mistakes they made that led to the problems and set up a budget/financial plan that will help them to rebuild their financial standing.”
Tracy Becker is the President and CEO of North Shore Advisory, Inc., a leading Credit Restoration, Education and Monitoring Company specializing in Business & Personal Credit Services. Tracy is a FICO Certified Professional & Expert Credit Witness, she has been improving both consumer and business credit as well as educating professionals and individuals for almost thirty years. North Shore Advisory has helped thousands of businesses and individuals to have the most opportunity and savings great credit can offer.
Randall R. Saxton (@SaxtonLaw) is the founder of Saxton Law, PLLC, and practices in the areas of bankruptcy, tax, business formation, and estate planning. Randall also serves as the JAG for the Mississippi State Guard, President of the State Guard Association, as a Director of the Madison Chamber of Commerce, and is the author of the fictional thriller, Red Sky Warning. He does volunteer work as a Mediator for the Jackson Municipal Court and as an Emergency Response Team member.
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The information contained herein is provided for free and is to be used for educational and informational purposes only. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. Articles provided in connection with this blog are general in nature, provided for informational purposes only and are not a substitute for individualized professional advice. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the OppLoans blog.