What Does Bankruptcy Do To Your Credit Score?

Filing for bankruptcy is not an easy decision to make and for many people, it’s a last resort. There are different types of bankruptcy, but in general, filing for bankruptcy can discharge all or a portion of your consumer debt. 

The tradeoff is that bankruptcy will negatively affect your credit score and remain on your credit report for several years. 

If you’re considering bankruptcy, it’s important to weigh all your options and know how it will affect your credit score as well as what you can do to recover your credit afterward. 

Highlights/Key Takeaways

• Bankruptcy will be on your credit report for seven to 10 years.
• Bankruptcy will damage your credit score, but in some cases, the fresh start it offers can help you rebuild your credit.
• Having a bankruptcy on your credit report can make it challenging to access new credit, but you do have options. 

What Bankruptcy Means for Credit Scores

Bankruptcy is a legal process that helps people who can no longer repay by either discharging (eliminating) their consumer debt or by restructuring their debt repayment plan through a settlement option. 

Not all types of debt can be discharged in bankruptcy, but it can provide immediate financial relief by erasing credit card balances, medical bills, past-due rent payments, payday loans, overdue utility bills, car loan balances, and mortgages. 

While bankruptcy can be necessary, it does have financial consequences such as: 

• The loss of your property
• Damage to your credit score
• Difficulty accessing new credit

Regardless of the type of bankruptcy, you can expect it to impact your credit score as it’s likely to drop by several points. 

For consumers, there are two main types of bankruptcy options:

• Chapter 7: This type of bankruptcy liquidates an individual’s assets and uses it to pay creditors. As a result, Chapter 7 bankruptcy will discharge unsecured debts such as credit cards, medical bills, and personal loans.
• Chapter 13: This type of bankruptcy allows the individual to keep their property and get on a debt repayment plan that allows them to pay back a portion of their debt as a negotiated settlement.

Chapter 7 Bankruptcy vs. Chapter 13 Bankruptcy and Your Credit Score

Chapter 7 bankruptcy is also known as liquidation bankruptcy and can stay on your credit report for up to 10 years. While this option gives you a chance to start over in a sense without the heavy burden of debt, it can severely damage your credit score since credit scoring models and lenders favor individuals who repay their debts. 

With Chapter 13 bankruptcy, also known as a wage earner’s plan, your repayment plan will last anywhere from three to five years. As long as the bankruptcy is on your credit report, it will have a negative impact. With Chapter 13, that’s at least seven years.

All the accounts impacted by bankruptcy will be listed on your credit report. Some accounts may drop off your credit report sooner, but it depends heavily on the creditor and your unique situation. 

With Chapter 13 bankruptcy, some accounts may stay on your credit report longer since the seven-year period does not begin until an account is inactive. 

What Your Credit Score Will Look Like After Bankruptcy 

The impact bankruptcy has on credit scores will vary based on the individual’s situation and their starting credit score. Generally, the higher your score, the more it will drop. 

However, if you already had poor credit prior to filing for bankruptcy, the decrease in your credit score may be more moderate.

For example, someone with a credit score of 680 would see their score drop by 130 to 150 points after bankruptcy according to Debt.org. Someone with a starting credit score of 780 may see their score drop by 200 to 240 points. 

Someone with an average or great credit score will likely experience a noticeable decrease. However, if your credit score is very low such as 400 or 500, you may see a slight improvement by 50 points, for example.  

In this case, bankruptcy could slightly improve a very low credit score since delinquent accounts will be discharged and it could improve the debt-to-credit ratio. Credit utilization is a factor that heavily impacts credit scores as well as debt balances. 

The higher your balances and the more revolving credit your utilizing, the lower your score will be. In situations like this, discharging that debt through bankruptcy could result in a slight credit score boost. 

When to File for Bankruptcy 

Bankruptcy is intended for people who are carrying an unmanageable amount of debt. It’s often a last option for those who have much more debt than they can afford to pay back and don’t see their situation changing in the near future. 

Common reasons to declare bankruptcy can include:

• Medical debt. Surgeries and medical bills can result in tens of thousands of dollars and providers will send these unpaid bills to collections after a while. 
• Student debt. High student loan debt balances are another heavy debt burden especially if you were not able to earn a degree or find a suitable paying job after school. 
• Loss of income. Losing income due to a health issue or another reason and remaining out of work long-term could also lead to your debt balances growing beyond control. 
• Mortgage that is too expensive. As other bills add up, property taxes increase, or you struggle to pay your mortgage and an outstanding home equity loan, it may become too expensive to afford your home altogether. 
• Spending beyond your means. High credit card debt balances can be crippling as well when you factor in credit card interest rates and late payment fees. 

If you’re considering bankruptcy, you also want to carefully weigh the consequences and benefits of this decision. Consider talking to a bankruptcy lawyer or credit counselor to see if you qualify for bankruptcy and which option would be best for your situation. 

Also, you’ll want to look at your debt to determine which accounts can actually be discharged since not all debts qualify for bankruptcy. Tax debt, unpaid child support, alimony, and government student loans can’t be discharged through bankruptcy.

The best way to understand all your options is by working with a qualified bankruptcy attorney. 

Assessing the Alternatives of Bankruptcy 

Bankruptcy is not the only option for people who are overwhelmed by debt. Below are a few alternatives to consider if you’re still on the fence about filing for bankruptcy or question if it’s the best decision for you. 

• Credit counseling: Credit counseling organizations can advise you on your debt and help you come up with a realistic payment plan. Credit counselors can also provide guidance on budgeting, saving, and other financial challenges you may be facing. Ultimately, a credit counselor’s goal is to help you get out of debt, and you find a credible credit counselor through the National Foundation for Credit Counseling. 
• Debt consolidation: Debt consolidation involves combining several debt balances into one new loan. This can help simplify your situation so you’re just paying one monthly payment on your debt instead of several payments with different interest rates. The American Consumer Credit Counseling organization provides more details on government debt consolidation programs. 
• Debt management: If bankruptcy is truly a last resort, check to see if there are any ways to manage your debt first before trying to file. This could involve negotiating with creditors, asking for an interest rate deduction, or even getting a part-time job to accelerate debt payments. Consolidated Credit offers several specific debt management resources to help.

How Long Does A Bankruptcy Stay On Your Credit Report?

Chapter 7 bankruptcy can stay on your credit report for up to 10 years from the filing date. Chapter 13 bankruptcy can stay on your credit report for up to seven years.

However, the negative impact on your credit can be reduced over time as you take steps to build positive credit history moving forward.  

How to Rebuild Your Credit After Bankruptcy 

One of the few benefits of filing for bankruptcy is that it can give you a clean slate and a new opportunity to rebuild your credit with time. 

If you file for bankruptcy, it’s important not to focus on the past and to shift your focus to establishing healthy financial habits to rebuild your score in the future. Here are some specific ways to rebuild your credit after filing for bankruptcy. 

• Start by getting on a clear budget you can stick to. Tracking your expenses and income will help you know what you can and can’t afford. This comes in handy if you’re tempted to overspend or max out a credit card. 
• Focus on improving some of the key factors that impact your credit score such as payment history. It’s important to pay your bills and credit cards on time consistently as well as to keep your credit utilization low (preferably under 30%). 
• Consider a secured card. Secured credit cards are easy to qualify for and the creditor will report all your payments to the three major credit bureaus. 
• Or, try a credit builder loan. Credit builder loans are usually offered by banks or online lenders and allows you to borrow a small sum of money. You’ll build your credit as you make timely payments on the loan. 
• Avoid working with credit repair companies that don’t seem legitimate or helpful. If anyone asks for you to pay them upfront or recommends you stop paying creditors in exchange for their services, this could be a scam and actually hurt your credit score. 

Reputable credit repair companies must comply with the Credit Repair Organizations Act which states they can not make false statements about what they can do for you and cannot charge you before they have done any work. 

Accessing Credit Cards and Loans After Bankruptcy   

Rebuilding your credit after bankruptcy takes time and you may even want to avoid trying to access new credit shortly after filing. 

Large purchases can be tough because you may not qualify for a mortgage or auto loan without receiving very high interest rates. Taking on new debt at a high interest rate could put you right back in a stressful financial situation. 

If you need to get a loan or apply for credit, consider seeing if a friend or relative be a co-signer on your loan. Also, shop around using loan comparison sites to compare quotes and loan terms. Many online lenders allow you to pre-qualify first online with only a soft credit inquiry so your credit is not impacted. 

Some lenders also cater to borrowers who have bad credit or have filed for bankruptcy before and will be more willing to work with you. Just be sure to carefully read the loan terms and watch out for high rates and fees. 

Making a financial recovery plan and sticking with it will help you rebuild credit over time. It may take a few years, but as your credit improves, you’ll be able to access credit cards and loans with better interest rates. 

Final Word

If you’re struggling with debt, bankruptcy is not the best option for some people and has serious consequences, including a damaged credit score. 

However, filing for bankruptcy can be a solid option for someone who is extremely overwhelmed by their debt, looking for a fresh start, and is willing to spend time rebuilding their credit score. 

After filing for bankruptcy, the key is to start taking specific actions to repair your credit such as getting a credit builder loan, using a secured credit card, and paying bills on time.