People are often wary about filing for bankruptcy because they know the bankruptcy will show up on a credit report. There is no denying that a bankruptcy has an impact on a credit score, and that lenders may be reluctant to extend no credit to debtors who have filed bankruptcy.
Realistically, however, by the time debtors are considering bankruptcy, their credit scores have already been damaged. Consumers only resort to bankruptcy when their debt has become unmanageable. They have probably maxed out their credit cards. They have usually missed some payments. Perhaps their wages are being garnished or their mortgage lender has sued for foreclosure. All of those events have a negative impact on credit scores.
In the short term, filing bankruptcy might make it difficult to obtain new credit, although even before a bankruptcy filing, obtaining new credit is not usually an option for debtors who cannot pay their bills. In the long term, filing bankruptcy might make it easier to obtain credit by stabilizing the debtor’s financial situation. How long that will take depends upon the efforts a debtor makes to rehabilitate his or her credit score.
Bankruptcy and Credit Reports
A Chapter 7 bankruptcy remains on a credit report for ten years. A Chapter 13 bankruptcy can no longer be included in a credit report after 7 years. However, the appearance of a bankruptcy on a credit report is only one factor that financial institutions rely upon when they extend credit. A consumer’s credit score is the most important factor that influences the decision to grant a loan or issue a credit card.
Bankruptcy is one of many adverse events that affect credit scores. The good news is that adverse events are given less weight as time passes. While a bankruptcy will appear on a credit report (and therefore affect a credit score) for several years, it will have a diminishing impact over time, particularly if the consumer has taken steps to improve his or her credit score after a bankruptcy discharge is granted.
Bankruptcy and Credit Scores
Credit scores are determined by the three credit reporting bureaus: Equifax, Experian, and TransUnion. They rely on similar methods to calculate a credit score, and the scores calculated by each bureau generally fall within the same range.
Credit scores are influenced by many factors. They include:
- How much credit is available to the consumer
- How much of the available credit the consumer has used
- Whether and how often the consumer has been more than 30 days late in making a payment
- Whether judgments for unpaid debt have been entered against a consumer
- Recent reductions in income
- Recent requests for credit limit increases
Credit scores typically range from 300 to 850. A “good” credit score is usually defined as being in the range of 690 to 700. An “excellent” credit score is typically defined as 750 or higher.
A bankruptcy will probably lower a credit score by 130 to 240 points when it first appears on a credit report. As a general rule, a Chapter 13 bankruptcy will have less impact on a credit score than a Chapter 7 bankruptcy.
Consumers with a credit score below 650 might have difficulty obtaining credit. Few financial institutions will offer credit to consumers who have a credit score below 620. Some financial institutions will make credit available to consumers who have a credit score between 620 and 650, but will charge a higher interest rate. Some lenders will not make loans to anyone with a credit score below the number they define as “good.”
The impact of a bankruptcy will vary from debtor to debtor, depending on other factors that affect the credit score. For example, as credit card companies close accounts in response to a bankruptcy, the factor of “maxed out credit cards” will no longer harm a credit score. The exact amount by which a bankruptcy reduces a credit score is therefore difficult to predict.
Consumers can predict that their credit score will improve each year (and perhaps each quarter) after the bankruptcy discharge is granted. That improvement can be hastened by taking some simple steps to rehabilitate the consumer’s credit.
The appearance of a bankruptcy on a credit report does not make it impossible to obtain credit. Consumers who have sufficient income are often able to obtain a mortgage loan four years after a bankruptcy discharge, and as soon as two years after the discharge if they qualify for a government-backed FHA or VA loan.
Obtaining new credit, however, will depend on having a credit score that meets the lender’s standards. Here are some steps to take after filing bankruptcy to improve that score:
- Pay bills on time. Consumers who don’t have credit still have bills, including rent and utility payments. A judgment for nonpayment of those bills is another adverse event that lowers a consumer’s credit score. Paying bills is essential to rehabilitating credit.
- Get a secured credit card. Applying for ordinary credit cards with a low credit score is usually a waste of time. In fact, a flurry of applications will reduce a credit score. However, most people can obtain a secured credit card after bankruptcy. The consumer must post cash as security which will be used to pay the balance if the consumer misses a payment. A consumer who makes timely payments will begin establishing a positive credit history that will be reflected on a credit score.
- Obtain a car loan. If you need a new car, it is usually easier to obtain a car loan with a low credit score than other loans. Car loans are secured by a lien against the car, and dealers who are anxious to sell cars often do business with loan programs that make credit available to people with low credit scores. Make sure you can afford the loan payment and don’t get suckered by unreasonably high interest rates. If the payments are unfair or more than you can handle, walk away.
By rehabilitating credit, the presence of a bankruptcy on a credit report will no longer be a barrier to establishing new credit. The means debtors can often obtain new credit without waiting seven or ten years for the bankruptcy to disappear from a credit report.