Many people think of bankruptcy as financial Armageddon, the final act in a downward spiral that ends with a judicial order that discharges the debt. As bad as bankruptcy is, it doesn’t leave a lifelong black mark on your finances, but restoring your financial good name takes effort as well as time. You ask, how bankruptcy impacts your credit score? There are a few ways. Before you panic, claiming bankruptcy isn’t the end all be all.
If you are delinquent on many accounts and your debt-to-asset ratio is high (meaning you have lots of debts and few assets), your credit is already in the tank. If you file for bankruptcy, your score will take a modest dip, but it won’t take a huge plunge. If, on the other hand, your credit is good before you file for bankruptcy, then your score will take a much bigger hit post-filing
There’s the damage done to your credit. It’ll likely take years to recover. But bankruptcy doesn’t have to be a life sentence: Here’s how to start improving your credit scores today.
Chapter 7 and Chapter 13 Bankruptcy and How Bankruptcy Impacts Your Credit Score
Both Chapter 7 and Chapter 13 are common forms of consumer bankruptcy. Under Chapter 7, the debtor generally does not pay anything bank to his or her creditors. Under Chapter 13 the debtor pays some or all of the debts back; Chapter 13 filers can pay anywhere from 1 percent up to and including 100 percent of the debts. The amount being paid back depends of the debtor’s income and other factors. Because most Chapter 7 filers pay nothing to creditors, most people prefer to file under Chapter 7. However, not everyone qualifies for Chapter 7 protection. If your income is above a certain level, you may be required to file under Chapter 13 and pay something back.
Both Chapter 7 and Chapter 13 are going to affect your credit score in similar ways. Most filers end up with a score in the mid-500s.
Higher starting scores take a bigger hit than lower ones. For example, a high credit score of 780 will probably go down to around 540, a drop of 240 points.
A lower score, such as 680, will go down to around 530, a drop of only 150 points. In any case, most people land in that mid-500 range.
Before you write off bankruptcy as an option because of the effect on your credit, consider that your score already takes a hit whenever you miss a payment. Most people considering bankruptcy already have lower scores.
How Long Does Bankruptcy Stay on a Credit Report?
The most common type of bankruptcy – about 70% of those filed each year – is Chapter 7 bankruptcy and it remains on your credit report for 10 years. The other type, Chapter 13 bankruptcy, clears from your credit report after seven years.
Chapter 7 lasts longer on your record because, after you liquidate assets and pay what you can, the rest of the debt is written off. Chapter 13 bankruptcy involves a plan to continue paying off at least part of your debt in three to five years, so it leaves your credit report sooner.
Getting the bankruptcy removed from the credit report early won’t happen simply because you don’t want it there. It requires proving that it didn’t belong there in the first place, meaning that it is the result of identity theft or a clerical mistake that you can prove to be the case.
Recovering From a Bankruptcy
You’re likely dealing with a multitude of financial, and perhaps personal, problems immediately following a bankruptcy. You may want to start by focusing on those, and when you’ve got a little breathing room, you can start taking steps to improve your credit as well.
In fact, even if you somehow magically got your credit score to jump up to a perfect 850 in a month, the bankruptcy could still affect your creditworthiness. A credit score is just one factor that creditors consider when reviewing your application and underwriting a loan or credit account. In some cases, regardless of your credit score, you may be automatically rejected for a credit card application if you’ve had a bankruptcy within the last couple of years.
3 Ways to Rebuild Credit After Bankruptcy
- Secured credit cards offer generally feature easier qualification standards than traditional, unsecured credit cards.
- Credit builder loans tend to be easier to qualify for, even with past credit problems.
- Authorized user status might help you if a loved one adds you onto an existing, well-managed credit card.
Regardless of the type of accounts you open, be sure to make every payment on time. With credit cards, it’s also important to pay your balance in full monthly and keep a low debt-to-limit ratio on the accounts.
Can You Speed Up the Removal Process?
The FCRA lets the credit bureaus include bankruptcy filings on credit reports for up to 10 years in some cases. But there are other rules the credit bureaus must follow as well. Namely, any information a credit bureau includes on your credit report should be 100% accurate.
Credit reporting errors aren’t uncommon after a bankruptcy (or at other times, for that matter). In a study by the Federal Trade Commission, 25% of consumers found errors on their credit reports that might impact their credit scores.
If you discover an error or questionable information on your credit report, you have the right to dispute the item. This rule applies to bankruptcies too. You can dispute a bankruptcy you disagree with on your own or with professional help.