One of the ways you can hit “rock bottom” financially is by declaring bankruptcy. If you are currently struggling to pay your bills, here are a few things you should know about how bankruptcy affects your credit score. It just might help save your credit.
Chapter 7 and Chapter 13 Have the Same Effect
There are two different forms of personal bankruptcy. Chapter 7 is a means-tested bankruptcy and Chapter 13 generally applies if you have a salary higher than the median income for your state.
Either way, bankruptcy is bankruptcy when it comes to your credit history. Both chapters will lower your credit score equally.
Bankruptcy Stays on Your Credit History for 10 Years
Declaring bankruptcy will keep a record of the event on your credit score for up to 10 years. Some bureaus and lenders will stop reporting bankruptcy after 7 years. This is in addition to any missed payments you had leading up to declaring bankruptcy. Bankruptcy will have the largest affect on your credit immediately after you declare it.
As you approach the 10-year mark, your score will gradually improve. Once the credit bureaus stop reporting your bankruptcy status, your credit score should improve rapidly if your finances have improved.
Bankruptcy Can Drop Your Credit Score 200 Points
There isn’t a “cookie cutter” answer to just how low your credit score will go once you declare bankruptcy. But, it does tend to have a larger negative impact on people with higher scores. This is because people with damaged scores are already considered riskier and their score can’t go much lower.
People with excellent credit scores of 700 or above can easily see their scores drop up to 200 points. Those with fair credit scores close to 600 can expect a 100 point drop or higher.
A Tip from the Finance Genie: If you want to see your credit score go up, follow these 3 Simple Tricks to Improve Your Credit Score!
Some Debts Still Need To Be Paid
Declaring bankruptcy can allow some debts to be discharged due to financial hardship. Two types of loans that you still might be responsible for paying are student loans and your home mortgage. Loans that need to be repaid might be transferred to a collections agency that will collect the payments instead of the original lender.
For other loans that are not discharged and the lender doesn’t have collateral (the lender can’t seize your college degree as collateral for delinquent student loans), the lender can issue a court judgment after the initial 10-year bankruptcy filing period has expired.
A court judgment can be collected with garnished wages and you can be responsible for legal fees too. And, your credit score is penalized yet again as judgments remain on your credit history for up to 10 years too.
Bankruptcy Disqualifies You From Future Credit
Declaring bankruptcy also makes it very difficult to qualify for future credit applications while the event remains on your credit history. One way to improve your credit score is to apply for a secured credit card. You will have a very small credit limit and might even have to pay an annual fee, but, it’s an easy way to gradually rebuild your score without borrowing money.
Bankruptcy Can Be The Easiest Way To Rebuild Your Credit
While declaring bankruptcy is a personal decision, you don’t have to declare it to rebuild your credit. Keep in mind that it can allow you to rebuild your credit sooner as some of your current debts are discharged by lowering your debt to income ratio.
Just remember that bankruptcy will remain on your record for up to 10 years and cause another drop in your credit score. If you can afford the monthly payments and want to keep your record clean, not declaring bankruptcy can help you long-term. Just like how this guy improved his credit score nearly 200 points in 4 months.
Also, some loans like student loans and mortgages can’t be discharged during bankruptcy hearings and bankruptcy will harm you more than help you.
Bankruptcy Can Cause Credit Reporting Errors
While the likelihood of having a credit reporting error are rather slim, they still do happen. By checking your credit reports once a year on annualcreditreport.com (it’s free!) or another free site such as Credit Karma or Credit Sesame, you have the opportunity to comb your report for reporting errors.
This errors can bring down your score. Once these errors have been corrected, your score will return to where it actually should be.
Bankruptcy doesn’t mean that you will never qualify for a low-interest rate loan or good rewards credit card again, but, it might be a few years. Whether you declare bankruptcy or not, implementing sound financial habits are guaranteed to help improve any credit score.