Filing for bankruptcy can give you relief from creditors and give you a fresh financial start. The fresh start usually does mean a major hit to your credit, particularly setting you back to a low credit score. However, there are ways that bankruptcy can help credit in both the short and long term.
How Bankruptcy Impacts Your Credit Score
When you first file for bankruptcy, your score will almost immediately be impacted negatively. Many think bankruptcy is the worst impact to your credit score when compared to other debt collections actions, such as foreclosure. However, no one knows how much damage specific things, such as bankruptcy or foreclosure, do to your credit. This is because credit scoring systems change, credit scoring agencies don’t make the formula they use public, and creditors also use different criteria when looking at your credit. If you currently have a good credit score and file for bankruptcy, then you will likely suffer the most. The higher your score is pre-bankruptcy, the bigger the drop will be after you file for bankruptcy. However, if you already have a low score then bankruptcy won’t hurt you as much. For example, someone who has a score of 680 before filing loses about 150 points. On the other hand, someone who has a score of 780 before bankruptcy can lose up to 240 points. If you already have a low score and then file for bankruptcy, it can be easier to improve your score after filing.
What Is a Credit Score?
Your credit score is a number that reviews your credit history and also predicts how likely you are to default on a loan. Lenders use a credit score in order to decide whether or not you should be granted a loan and how much interest to charge. FICO scores are the most common and range from 200 to 800. Things included in the FICO score are payment history, how much debt you currently have, how long you have had credit, and different types of credit in your profile.
How Bankruptcy Can Help You
If you are in a position where you need to file for bankruptcy, then your credit is typically not as significant as the reasons that led you to file for bankruptcy. Acquiring a new credit card or loan won’t be as pressing as mortgage foreclosure or wage garnishment. After you file for bankruptcy, you may find that it will help your credit, even if it does remain on the credit report for up to 10 years after you file.
There will be some immediate results for your credit after bankruptcy.
Removal of Delinquent Account Reports: If your credit report had high credit balances or late payments then this is where bankruptcy helps the most. Bankruptcy wipes away these debts. Debts that are discharged in the bankruptcy process no longer can be reported as delinquent. Instead, these debts are reported as discharged. This may even help an already low score.
Improvement to the Debt-to-Credit Ratio: The amount you owe on your credit accounts and loans accounts for about 30% of your FICO score. Bankruptcy may be able to help you improve your debt-to-credit ratio. This ratio is comparing your outstanding debt to your current available credit balance. The lower your debt compared to your available credit, the better it helps your score. If you have credit accounts with high limits, these are normally frozen or closed when you file. However, if you have debts with low balances and good credit limits, or you get new credit accounts after discharge, this may help your score. This is because you won’t have any debt compared to your credit limits, which means a better debt-to-credit ratio.
Bankruptcy gives you the chance to start over and wipe your debt history clean. This means you have another chance to get your finances in order. If you are disciplined with your money and budget correctly then you can start laying the foundation for good credit history. After you file for bankruptcy, it’s best to start some good habits and reestablish credit as soon as you can. Since you aren’t burdened with debt that was discharged in bankruptcy you might have some more disposable income in order to make your payments on time. If you keep up a good track record of paying any post-bankruptcy debts on time, then you can slowly increase your credit score. This could be as soon as six months after you file.
Credit Recovery after Bankruptcy
Building your credit again after bankruptcy is going to take some time. You want to start with a list of debts included in your bankruptcy and start checking them on the credit reports. It may take a month or two for the accounts to be updated on the report. Check your reports every few months for errors and make sure any errors are removed. You can also consider rebuilding your credit by using a secured credit card. You would only take out money that you can afford to pay back. It is possible to improve your score so that it is higher than it was before bankruptcy.