Does Chapter 13 Bankruptcy Ruin Your Credit?

Your credit will suffer when you file a Chapter 13 case, but it will drop from your credit report years before a Chapter 7 case would.

By , Attorney

Your credit report will reflect your decision to file bankruptcy for years after you file, so there's no escaping the reality that filing bankruptcy will negatively affect your credit. If you have the income to fund a repayment plan, filing under Chapter 13 bankruptcy might hasten your financial recovery.

Why Lenders Prefer Chapter 13 Over Chapter 7 Bankruptcy

Unsecured creditors (like credit card balances and medical debt) aren't usually paid anything in a typical Chapter 7 case because Chapter 7 bankruptcy doesn't require you to propose a repayment plan and make payments to creditors. Instead, you'll surrender any nonexempt property (property that you can't protect under your state's exemption laws) to a trustee assigned by the bankruptcy court who will sell the property and use the proceeds to pay your creditors. Most people who file a Chapter 7 can exempt most or all of their assets from the reach of the bankruptcy court, therefore, there isn't anything left to repay debt.

By contrast, in a Chapter 13 case, you'll make monthly payments to the court for three to five years. The trustee will disperse the funds to creditors that file valid proof of claims. Not all Chapter 13 plans propose to pay unsecured debts (this type is called a Chapter 13 zero percent plan), but because Chapter 13 bankruptcy offers some hope that the lender will receive payment, future creditors often see it as more desirable or having less impact on your credit.

Chapter 13 Bankruptcy and Your Credit Score

If you're considering filing a bankruptcy case, you've likely struggled with your debt for some time, and it has likely impacted your credit score. Filing a bankruptcy will probably not reduce your score much more. However, if your credit score is higher when you decide to file, a bankruptcy filing will have a greater impact.

Example. Suppose that you've been having trouble keeping up with payments for some time, and your credit score has dropped to 550 (which is considered poor). When you file for bankruptcy, your score isn't likely to fall much further. For instance, a higher score like 650 (considered fair), your score would probably drop to around 550.

It also makes little difference whether you file a Chapter 13 or a Chapter 7 bankruptcy, although it's hard to know the effect because the companies that produce credit scores don't release their formulas. Choosing a Chapter 13 over a Chapter 7 bankruptcy won't provide you much benefit if you're trying to preserve your credit score.

Obtaining Credit During and After Bankruptcy

While in a Chapter 13 case, you're generally prohibited from taking on any new credit. That can make life difficult if a major appliance breaks down or you need to replace your car while you're making payments on a three- to five-year plan.

The bankruptcy courts recognize that issues like this can derail your best efforts to make your Chapter 13 payments and that new credit can make the difference between a successful plan and the dismissal of the case. Should you find yourself needing to take on new debt, your attorney can help you locate a lender willing to work with a Chapter 13 debtor, as well as file a court motion asking for permission to take on the obligation.

After your bankruptcy case ends and you receive your discharge (the order that wipes out qualifying debt balances), finding credit isn't impossible even with a Chapter 13 case on your credit report, as long as you're willing (and able) to pay more in interest charges for the first few years. If you handle that credit responsibly, don't take on more than you can pay, and make timely payments, your credit score and interest rates will steadily improve.

Checking Credit Report Accuracy

Even if your credit score has dropped after your bankruptcy case, it's a good idea to review major credit bureau reports. You'll want to make sure that the reports show a bankruptcy discharge and not a dismissal. Review your reports carefully. Each of your debts should reflect "included in bankruptcy." Otherwise, lenders can assume that the debt wasn't discharged and remains unpaid, which can have an ongoing negative impact on your creditworthiness.

Although filing a Chapter 13 case might not help your credit score directly, it can get you on the financial recovery road more quickly than if you file for Chapter 7 bankruptcy. In general, negative information like late payments, charge offs, and judgments, can stay on your credit report for up to seven years. A Chapter 13 case will also remain on your credit report for up to seven years, but the time starts running from the date you file your case. Depending on the length of your plan, the Chapter 13 notation will drop from your credit reports two to four years after receiving your discharge—a significant improvement over a Chapter 7 bankruptcy, which the credit bureaus can report for up to ten years.

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