Many people considering Chapter 7 or Chapter 13 bankruptcy are worried about the effect that bankruptcy will have on their credit score. Although creditors don’t like to see a bankruptcy on your credit report, the damage it will do to your credit score depends, in large part, on how good your credit was before you filed.
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. (To learn about credit scores, including what it is and factors affecting it, see Your Credit Score: What It Is and Why It Matters.)
If you have a good credit score, filing for bankruptcy will definitely damage it. According to FICO (the most widely-used credit scoring company in the U.S.), those with good credit should expect a huge drop in their score immediately after filing for bankruptcy.
If your credit score is already low before you file for bankruptcy, then bankruptcy will cause only a modest drop in your score.
According to FICO (the most widely-used credit scoring company in the U.S.), whether you file for Chapter 13 or Chapter 7 bankruptcy makes no difference to your credit score. (Learn the difference between Chapter 7 and Chapter 13 bankruptcy .)
But it is possible that a potential creditor viewing your credit report will look upon one type of bankruptcy more favorably than another. For example, some creditors might view someone who files for Chapter 13—in which you repay some or all of your debts over a three to five year period—as more responsible, and thus a better credit risk, than someone who files for Chapter 7. (To learn more, see Is Chapter 13 Bankruptcy Better for My Credit Than Chapter 7?)
Bankruptcy won’t provide immediate improvement to your credit score, but for many people it can be the quickest way to a better score. Here’s why.
If you're already behind on debt payments, continue to fall further behind, or have accounts in collection, bankruptcy can help get you back on your feet sooner than other types of debt management programs. That’s because bankruptcy gets rid of many types of debts and provides you with a fresh financial start. When you reduce your debt load and get your finances under control, you can start making loan and credit payments on time, reduce your debt-to-income ratio, and take other steps to rebuild your credit.
If you don’t file for bankruptcy and continue to limp along—making late payments, defaulting on debts, and increasing the amount of debt you have compared to your income—you’ll never be able to improve your credit.
Keep in mind, however, that there are ways to get a handle on your debt other than bankruptcy. Check out all the alternatives to see what option is best for you. When in doubt, consult with an attorney. (To learn different ways to deal with outstanding debts, read Options for Dealing With Your Debt.)
Whether you can get loans or credit immediately after bankruptcy depends on what you are looking for.
Credit cards. Many bankruptcy filers are bombarded with credit card offers after the bankruptcy is over. Credit card companies know you can't file again for another several years (which means you can’t discharge any credit card debt you run up during that time), so they might be eager for your business. But beware—the credit card offers will likely have very high interest rates, annual fees, and other high charges.
Car loans. Most likely you’ll be able to get a car loan right away. But you’ll be dealing with subprime lenders, which means exorbitant interest rates and other unfavorable loan terms.
Mortgages. How long it will take to qualify for a mortgage depends, in large part, on the mortgage lender. You might qualify for an FHA-insured mortgage even before you complete a Chapter 13 plan and two years after a Chapter 7. For conventional loans, if your lender sells its loans to Fannie Mae or Freddie Mac, you’ll have to wait at least two years after Chapter 13 and four years after Chapter 7 (unless there are extenuating circumstances, and then the waiting period is two years). If your lender doesn’t sell its loans to Fannie Mae or Freddie Mac, you might have to wait even longer.
These are minimum wait periods—it might take much longer to qualify for a mortgage. Other factors that affect your qualification include your income, your debt load, how large your down payment will be, and more. (To learn more, see When Can I Get a Mortgage After Bankruptcy?)
If you file for either Chapter 7 or Chapter 13 bankruptcy, it will appear on your credit report for up to ten years.
If you apply for a loan or life insurance policy in an amount greater than $150,000 or apply for a job with an annual income great than $75,000, credit reporting agencies can report your bankruptcy longer than ten years. As a practical matter, however, most credit reporting agencies will delete the bankruptcy after ten years. (To learn how long other types of negative information will remain on your credit report, see How Long Does Negative Information Stay on a Credit Report?)
Even though bankruptcy remains on your credit report for up to ten years, you can start rebuilding your credit right away. Credit scoring companies look at several factors when computing your score:
(For details on each of these factors, see Your Credit Score: What It Is and Why It Matters.)
You can start to improve your credit after bankruptcy by making all of your payments on time. Keep your debt load low, especially as compared to your available credit. And when you are ready, get a credit card, make small charges, and pay the bill off in full every month. (To learn more, see Ways to Rebuild Your Credit.)