Declaring bankruptcy can damage your credit significantly. Here’s what you need to know about declaring bankruptcy and what you can do to rebuild your credit.
Every year, thousands of Americans declare bankruptcy, believing it to be their only option to recover from the debt they’ve accumulated. Bankruptcy can be a helpful option if your debt has spun out of control and you truly can’t pay it off. But you should view it your last resort, because it will wreak havoc on your credit.
Types of bankruptcy
Personal bankruptcies will generally be categorized as Chapter 7 or Chapter 13 bankruptcy, though there are other chapters. Chapter 7 cancels most debt (with significant exceptions including taxes, alimony, child support and student loans), and filings will only take four to six months. But you have to prove that you truly cannot meet your debt obligations – the requirements will vary from state to state. This is meant to stop anyone with the ability to pay their debts from getting out of this obligation.
See related: 14 key factors when considering bankruptcy
A Chapter 13 bankruptcy (sometimes called a ‘wage earner’ bankruptcy) will reorganize debt so that you repay at least a portion of it, based on a very lean, court-imposed budget over time. Chapter 13 bankruptcy is a much longer process than Chapter 7. It can take three to five years to complete.
How long does a bankruptcy stay on your credit report?
A Chapter 7 will remain on your credit reports for 10 years, while a Chapter 13 stays for seven. But the recovery period for your credit score is not as long as either of those periods. The fact that the bankruptcy stays on your reports is significant, though, because it will be visible to anyone who pulls your credit report. Remember that your credit report is not just used by lenders. Insurance companies, landlords and employers might also see it. While bankruptcy is perfectly legal, you cannot control the way it is perceived by others.
How long does bankruptcy affect your credit score?
You can expect recovery to begin fairly quickly after discharge, though there is no hard and fast timeline. A lot will depend on how you move forward: You must be very diligent about paying your bills as agreed. This is the best way to recover as quickly as possible.
Can you remove a bankruptcy from your credit report early?
Just like all timely and accurate information, the record of your bankruptcy is not something you can delete from your file. Time and a solid recovery plan are the only remedies here, no matter what you may be told to the contrary.
Building your credit back up after bankruptcy
A bankruptcy results in a very low credit score. The higher your score before the bankruptcy, the more points it will lose after. And it will stay low for a very long time unless you take positive action to improve it.
Here are the top scoring factors that are influenced by a bankruptcy and what you can do about them:
- Timeliness of payments: Expect this category to be heavily affected. After you get new credit, be sure to make all your payments on time, every time.
- Amount and proportion of credit used: Your accounts will likely be closed, which will drop your available credit down to $0. As you reestablish credit, try to keep balances under 20% of your limit for best results.
- Length of time you’ve been using credit: Your score is damaged because the aging history on your accounts stops at your filing. New, positive accounts will be reported for at least 10 years after they are closed and sometimes longer.
- Variety of accounts: Bankruptcy typically leaves you with only secured installment debt such as mortgages, student loans or car loans. Consider a secured credit card passbook loan or credit builder loan to restart your revolving or installment credit history. Also, consider keeping one or two of your lower balance cards open by reaffirming them.
- Number and types of accounts you’ve opened recently: Following bankruptcy, you may have more new credit inquiry activity than usual as you attempt to reestablish your credit. And your score will fall more as a result. To minimize damage, don’t apply for more accounts than you need.
Whether you choose to file for bankruptcy or not, I strongly suggest that you come up with a game plan to move forward. It might not work out exactly as you want it to, but it will give you the motivation and tools to achieve your financial goal. Having a plan will also help you realize when you’re drifting.
The post-bankruptcy class you’re required is a great resource to help you come up with a plan, so pay close attention. Working with a counselor to develop a detailed spending plan that includes saving for financial goals. That way you’ll be able to avoid getting into trouble again, even if an emergency arises.
Remember to keep track of your score!