Credit Repair

4 Ways Bankruptcy Affects Your Credit

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Filing for bankruptcy is one of the most serious financial decisions a person can make, and one that can have tremendous repercussions on their credit and livelihood for years to come.

“The short-term impact of bankruptcy on your credit score can be devastating, but time and a positive post-bankruptcy account history can help turn things around,” said Bruce McClary, vice president of marketing at the National Foundation for Credit Counseling. “The amount of time and effort it will take to recover is enough to make other debt relief options worthy of consideration.”

But for those who are desperate to get out of debt, stop foreclosure activity or repossessions and ward off debt collectors, there may be no better option. Roughly 13 million Americans filed consumer bankruptcy petitions in the federal courts between 2005 and 2017, according to the Administrative Office of the U.S. Courts, though Chapter 7 bankruptcies declined after 2010.

If you are considering filing for bankruptcy, here’s what you need to know about the different types and how bankruptcy might affect your credit.

Types of bankruptcy

There are six types of bankruptcy, but Chapter 7 and Chapter 13 are the two most commonly used by consumers.

Chapter 7 bankruptcy involves the liquidation of most of your property, meaning it is sold to raise funds to pay your outstanding debts. While this may end up being the best solution for someone in serious debt, Chapter 7 bankruptcy does not give you the option of excluding any debts. This means there is no option to hold onto a credit card or keep certain creditors out of the filing.

Chapter 13 bankruptcy allows you to reorganize your debts by entering into a monthly repayment program. These programs last for three to five years and must be approved by the bankruptcy court. An advantage of filing for Chapter 13 is that you may be able to retain your property if you successfully complete the repayment program.

4 ways bankruptcy affects your credit

There are several ways bankruptcy can affect your credit. Let’s take a look.

A black mark on your report. A Chapter 13 bankruptcy remains on your credit report for up to seven years, and a Chapter 7 bankruptcy will stay for up to 10 years. As long as those marks are on your report, they can drag down your score.

Debt obligations wiped out but still impact credit. Bankruptcy can help eliminate many types of debt, and that can include unsecured debt like credit card accounts, medical bills and personal loans. It does not include child support, alimony, most student loan debt, federal tax liens or fines and penalties assessed by the U.S. government or a court.

But just because the debts are wiped out doesn’t mean they won’t affect your credit. Each account that is included in the bankruptcy can stay on your credit report for seven years from the account’s original delinquency date; that’s the date of the first late payment.

A bankruptcy record could turn off future lenders. A bankruptcy is like an emergency flashing signal on your credit report, so it can make it difficult to do things like rent an apartment or get a car loan. Even after bankruptcy, it might be hard to get approved for credit since lenders may consider you a bigger risk.

Your credit score could tank. Declaring bankruptcy will always hurt your credit score, though how much depends on your score when you begin the process. If you’ve missed payments and maxed out your cards for a while already (which is likely), your credit score has probably already taken a hit. In that case, the bankruptcy may not lower your score as much as it would for someone starting with a higher score. According to MyFICO, someone with a 780 credit score who declares bankruptcy might be docked 240 points, while a person with a 680 credit score could lose just 150 points. It’s worth noting they will likely end up with roughly the same score once the bankruptcy appears on their credit reports.

How to rebuild credit after bankruptcy

While the bankruptcy period can feel interminable, it is not forever. The more time that lapses, the less influence the bankruptcy has on your score — even if it hasn’t come off your report yet. And once the bankruptcy and the accounts that were included in the filing are removed from your credit report, you can take active steps to improve your credit score. Here are a few steps you might want to consider:

Look into credit builder loans. These are personal loans in which the lender deposits the funds — typically a small amount such as $500 or $1,000 — into a savings account for the borrower. The borrower then makes monthly payments against the principal and interest for the full term of the loan. Interest may be over 10%, and the loan generally ranges from six months to two years.

Once the loan is paid in full, the borrower receives the funds, plus any earned interest, in a lump sum. It’s important to make sure the lender issuing the credit builder loan reports payments to the credit bureaus.

Make payments on time. You may not be able to discharge all obligations through bankruptcy. For things like student loans, child support, alimony and certain fines and taxes, the key is to keep making timely payments throughout your bankruptcy. The same goes for any accounts post-discharge. Remember that payment history accounts for about 35% of your FICO Score; you can’t change the past, but making timely payments now can help rebuild your credit.

Be financially responsible. Credit counseling is required by the federal bankruptcy code as part of a bankruptcy petition. While it may seem like a hassle, the tools provided, like budgeting tips, can be useful in becoming more financial responsible. Being careful about amassing too much new debt and living within your means can help protect you from ending up in desperate financial straits again.

The bottom line

Because the repercussions of having a bankruptcy on your credit report can be great, consumers often don’t choose to file unless it’s a last resort. Be sure to carefully consider all options and understand the impact a bankruptcy filing can have before before making such an important decision. If you do decide to go that route, being prepared and knowing how to bounce back once the bankruptcy is discharged can make the process easier to manage and help make it a positive step toward a better financial future.

 

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