A lot of uncertainty comes when filing for bankruptcy. You set out in life with dreams of financial prosperity, only to need bankruptcy relief when life gets in the way. There are several anxieties and fears that will emerge and overwhelm you when you as an individual initially file for either Chapter 7 or Chapter 13 Bankruptcy Relief. Even though you know this is the best decision for you in the current moment, you cannot help but think of the future and what negative ramifications might sprout from his decision.
One of the most common concerns is that filing for bankruptcy will damage or decrease your credit score. Will declaring bankruptcy bring your credit score down far enough to the point where you will be denied loans and mortgages? What other elements of your life will this impact? While bankruptcy will unavoidably impact your credit score, many do not know in which ways it will be affected. The reality, however, is far less frightening than whatever imagined apocalyptic scenario you imagined. While it might take years to purge a bankruptcy record from your credit history, the reality is you can raise your credit score to a solid level within months of your filing.
How is Bankruptcy Reported on your Credit Score?
Bankruptcy is reported in several different ways on your credit score. Understanding how this is the case will be the first step in understanding not only how bankruptcy impacts your score, but also how to raise your credit score in the immediate aftermath of a bankruptcy.
Upon filing for bankruptcy, your credit report will indicate all overdue and unpaid debts. This includes any of the following:
• Judgement or legal debts
• Collection Liabilities
• Installment Liabilities
• Revolving Liabilities (such as credit card debts or utility debts)
Your report will reflect with each not only how much money you owe, but also the current status of the debt (most recent activity, the length of time these debts have remained open, and whether the debts are closed). It will be reported in your bankruptcy credit report whether there is a total balance on all these accounts. Some accounts without a balance may include ended car leases or closed credit cards.
How Does Credit Lower Thanks to Bankruptcy?
To understand how bankruptcy may negatively impact your credit score, it’s important to understand first how credit score is calculated. Your Credit Score is a number based on calculating the following factors:
• The number of financial and credit accounts open
• The types of said accounts
• Your payment history
• The length of your credit history
• Your used credit
• Your available credit
Credit score serves as a general reflection of your ability to balance multiple lines of credit, payment plans, and other financial responsibilities.
Bankruptcy affects and is affected by the multiple elements of what constitutes your credit score. Bankruptcy relief allows you to restructure payment plans to pay off outstanding debts. Unsecured debt, such as credit cards or medical bills, can be wiped out under Chapter 7 Bankruptcy. However, the more debts you wipe out, the heavier toll bankruptcy will take on your credit score. While this sounds bad, it’s vital to remember that the opposite is equally true. If you have a smaller number of financial obligations to wipe, their impact on your credit score will be minimal.
Chapter 13 Bankruptcy can set up new payment plans to catch you up to your current unsecured debt, usually over a 60-month period. Credit scores calculate how long it takes you to pay off outstanding debt, such as mortgage payments, car payment plans, and overdue credit. This will in the long run allow you to pay off your debts, which improves your payment history. If you did not file for bankruptcy, you might have struggled to make your payments. Many people believe bankruptcy leaves a purely negative impact on your credit history, but this is a case where filing for bankruptcy can improve your payment history rather than harm it.
Bankruptcy does not by default close outstanding secured debt. Therefore, collateral and liens may remain unaffected by declaring bankruptcy, unless under specific conditions. This gives you an opportunity, once you catch up to your other debts, to pay off your liens. Again, this offers you a net positive on your credit score. You would have struggled to pay off these secured debts previously, which would have both resulted in you losing your collateral and points on your credit score. However, with the relief offered by bankruptcy, it will be easier to pay your debts and thus raise your credit score.
However, while you can use bankruptcy as a chance to improve your payment history, many people worry that filing bankruptcy itself will greatly decrease your credit score. Payment history is a huge factor on your total credit score, so if you file for bankruptcy, the very event itself will weigh down your score. However, what many people don’t realize is that this decrease isn’t as catastrophic as you might believe it to be.
If you have a credit score of around 680 points, on average you can see your credit score drop around 130 points in the immediate aftermath of filing bankruptcy. The lower your starting credit score, the lower the damage will be. A credit score of 550 might seem like a far cry from 680, but it’s important to remember three vital things:
• This is JUST the immediate aftermath of declaring bankruptcy
• You CAN bring your score up
• This subtraction to your score WILL GO AWAY
How Long Does Bankruptcy Get Reported on Your Credit?
While bankruptcy does mark and affect your credit score, it is not a permanent black stain upon your credit report. Eventually, all bankruptcies get removed from your credit report.
Chapter 7 Bankruptcy remains on your credit report the longer, lasting for ten years following your initial filing. In contrast, however, Chapter 13 Bankruptcy will only continue to be reported on your credit for seven years. The same is true for any discharged debt, such as tax liens or judgement debts, that were tossed out thanks to your bankruptcy regardless of whether you file Chapter 7 or Chapter 13.
Following that seven- or ten-year period, your credit score will no longer be negatively affected by you declaring bankruptcy. It will surge back to a healthy, high number, seemingly negating any and all ill effect of you filing for relief. If the record of your bankruptcy disappears, then that 130 point drop we mentioned will dissipate. What’s good, though, is that by the time the weight of bankruptcy drops away, your score will have already beefed up considerably. You’ll be like a runner who trained with weighted clothing, springing on your toes the moment you let the weights drop. But in order to do that, you need to know what you can do to beef up your credit score as early as a few months after declaring bankruptcy.
How Can you Raise your Credit Score While Undergoing Bankruptcy?
There are a multitude of ways you can raise your credit score while undergoing bankruptcy. It is even possible to raise your credit score into a good range, depending on how many debts you can eliminate over time.
A common technique employed by people trying to raise their credit score is to open up new lines of credit, such as a secured credit card. Doing so will offset some of the bad, overdue credit you’ve previously accrued. Assuming your credit score is currently in the 500s, however, you should very easily be able to open new lines of credit.
However, it’s possible your credit score started low before declaring bankruptcy. If so, there’s still nothing to worry about. You just need to work at building your credit score. In order to build enough credit to secure credit cards, it might be a good idea to take out small credit builder loans then pay them off. These loans are forms of secured debt which require you to use a collateral. Paying these off will increase your credit score, which, after a while, allow you to take out new lines of credit.
Even if you can’t get new credit, there are ways to use existing credit cards to build your credit score. If you have multiple pre-existing credit cards, it is vital you maintain a significant amount of available credit open on your cards. While 30% is a good start, even more available credit might be able to push your credit score higher, especially if you maintain that available credit over the course of your bankruptcy restructuring and after.
Paying Debt while in Bankruptcy Might Help
One thing that will certainly help, however, is making timely payments for debt. Chapter 13 Bankruptcy will allow you to pay off debts over a three- to five-year period. During this time, it is essential that you pay every monthly payment in a timely manner. Doing so will increase your credit score by showing both you can make payments regularly while also decreasing the amount of unpaid debt on your credit history.
Leading into your filing, however, it might be best to settle as many debs as possible before declaring bankruptcy. Doing so will allow you to avoid the unpaid debts dragging down your credit score for the next seven to ten years as marks of your inability to pay off outstanding debt.
If possible, when arranging for payment plans under Chapter 13 Bankruptcy, attempt a briefer payment plan to catch up to current debt. By paying off debt over a three-year period as opposed to a five-year period, you can provide evidence of you paying off debt. This positive payment history can raise your credit score at a faster rate, which will allow you to build credit or open up new lines of credit faster, which, as mentioned before, will offset the bad credit you accrued leading up to bankruptcy.
Bankruptcy is not the end of the world like many people convince themselves it is. There are multiple strategies you can take in order to make the most of your financial relief. Within months of filing, you might feel proud enough of your credit score to brag about it.
Before engaging in any life-changing decision, it is a wise decision to consult a bankruptcy lawyer in your state to discuss strategies going forward. The attorneys at Scura, Wigfield, Heyer, Stevens & Cammarota LLP can help. Please call our offices to schedule a free consultation and hear your options.