Many people considering bankruptcy worry about its impact on their credit score and, more precisely, their ability to obtain credit and financing in the future.
So let’s not beat around the bush—filing bankruptcy will impact your credit score. The extent of the impact depends on the debtor’s personal financial situation (i.e. credit history and indebtedness) and which type of bankruptcy is filed. But it is important to remember that no matter the impact, it is temporary and may still be the right choice for you to eliminate unmanageable debt and start fresh.
Bankruptcy and Credit Generally
Most people who file bankruptcy can expect to see a 150-250 point drop in their credit score. For debtors with an already poor credit history, the raw decrease might be less. A few years ago, FICO published a report that showed the average credit scores after bankruptcy were between 500 and 550. Your credit report will reflect the bankruptcy for seven years if you file under chapter 13 and ten years if your file under chapter 7, though neither will preclude you from obtaining credit, especially as time passes and the report’s weight given to the bankruptcy decreases.
This can be scary and it sometimes deters people from filing bankruptcy. But if there is no hope of your financial situation improving on its own, it is likely to hurt your credit score as much or even more over time. Filing bankruptcy can be used to start fresh without unmanageable debt and actually may enable you to improve your credit over time in a way that otherwise may not be possible. This perspective is important.
How to Improve Your Credit Score After Bankruptcy
The good news is that it is possible to quickly begin to rebuild credit after bankruptcy. There are even programs designed to help people who recently filed bankruptcy purchase a car or even a home, but it is critical not to overextend yourself with new debt after bankruptcy.
The first thing we encourage our clients to do after bankruptcy is to review their credit reports and verify that the debts are reported accurately. The discharged debts should report a zero balance. If there are discrepancies, take appropriate action to dispute the reports and correct any errors.
Once your credit report is accurate, you can apply for new credit. There are plenty of credit programs out there aimed at people who recently filed bankruptcy. Unfortunately, not all of these lenders are virtuous, some do seek to exploit the situation with outrageous interest rates or other fees, so carefully research the lenders before entering into any credit agreements. One of the safest avenues may be a secured credit card with a relatively modest credit limit.
Use credit and pay on time. One of the biggest mistakes people make is converting to “cash only” after bankruptcy. The fastest way to build credit is to use credit. We usually recommend using a credit card like one ordinarily would use a debit card. Purchase items and make the full monthly payment immediately to avoid interest charges. You can carry a revolving balance, though most of the bureaus penalize balances greater than 30% of the total available credit limit. As you establish a new repayment history, you will be presented with additional opportunities to obtain more credit. We usually recommend opening no more than one new line of credit every six months. Rapid applications for new credit can hurt your credit score. Following these basic steps can substantially improve your credit score within the first year after bankruptcy.
Overall, we won’t lie to you. Bankruptcy hurts your credit score in the short-term. But often the impact is not as bad as many people think. If you are considering bankruptcy, take advantage of a free consultation with an experienced bankruptcy attorney to answer any questions you have and help you determine if bankruptcy is the right choice for you.