If you are considering bankruptcy, you may be wondering what effect a bankruptcy filing will have on your credit score. Will a bankruptcy filing ruin your credit forever? Is it possible to recover? How long will it take to rebuild my credit after bankruptcy?
What is credit anyway?
To understand how a bankruptcy will affect your credit, we first need to understand what “credit” actually is. When people refer to their credit score, they are referring to an assessment done by the credit bureaus of their credit risk. The credit bureaus (Experian, Transunion, and Equifax) compute data based on a combination of factors. Several of the factors include the total amount of debt you have, how many debt accounts you have open, the number of late payments on accounts, length of time accounts have been open, any judgments or liens filed, job stability, address stability, and we as other factors.
Your credit score is an overall grade of how risky it would likely be to lend you money. So a high credit score generally signifies that you are more likely to repay the loan, or in other words, less risky to lend money to.
What will bankruptcy do to my credit?
Most people that need bankruptcy relief already have a low credit score. They have already had their credit cards, medical bills, and other creditors report late payments. Frequently, their credit score has already taken a big hit and is in a downward spin. Bankruptcy can help these people to increase their credit score. The effects will happen both in the short term and long term. When you file bankruptcy, especially under Chapter 7, you are discharging or eliminating out most, if not all, of your debt.
This results in several things in the short term. First, when the bankruptcy is filed, the automatic stay of relief immediately stops creditors from continuing to report the accounts as delinquent. This will stop their credit score from continuing to drop every month, and will allow them to start rebuilding it. Second, the creditors will have report to the credit bureaus that the debtor no longer owes them anything upon entry of the bankruptcy discharge. Thus the credit report will now show these debts as having a zero balance. Having a lower outstanding debt tends to increase your credit score overall.
The long term effects are somewhat different. Individuals are allowed to file for chapter 7 bankruptcy once every 8 years. If a debtor needs to get a loan after their bankruptcy, they cannot eliminate that debt in another chapter 7 bankruptcy until 8 years have passed since the prior bankruptcy case. Because debtors cannot file bankruptcy again for 8 years, the likelihood that a creditor will be repaid are high, and therefore they may be more willing to lend money to a debtor that has a prior bankruptcy. Creditors still want to know that someone they are loaning money to has the ability to repay. Don’t expect to go apply for a car loan and get approved if you are unemployed.
Let’s continue the credit score discussion with Bankruptcy and Your Credit Score – Part II.