Bankruptcy is undeniably one of the worst things — if not the worst thing — you can do to your credit, typically causing a credit score loss of more than 200 points.
However, you can minimize the impact and hasten the recovery of your credit through better awareness of how credit scores treat bankruptcy. To do this we’ll need to set the record straight on some of the most commonly held misconceptions about how bankruptcy impacts credit scores.
Myth #1: Having no negative information on your credit report prior to bankruptcy leads to a higher post-bankruptcy credit score than if your report contained derogatory information prior to the filing.
Fact #1: While intuitively this logic might make sense — better credit management prior to the bankruptcy means lower future credit risk? — the reality is that a positive payment history on an account prior to it being included in bankruptcy does very little toward minimizing the damage to your score. Simply the presence of bankruptcy information on the credit report and, most importantly, the length of time since the information first appeared, are the strongest determining factors.
Myth #2: All bankruptcy information stays on your credit report for 10 years, without exception.
Fact #2: Actually, only the public record of a Chapter 7 bankruptcy lasts for 10 years. All other bankruptcy references on a credit report remain for 7 years, such as:
- Trade lines indicating “Account included in bankruptcy”
- Third-party collection debts, judgements and tax liens discharged through bankruptcy
- Chapter 13 public record items
Myth #3: You will have a low credit score for as long as the bankruptcy information remains on your credit report.
Fact #3: While it’s true that you should not expect a high score following bankruptcy, if you manage your credit optimally in its aftermath you can be looking at a 700 score or higher after only about 4-5 years. Such a speedy score recovery requires a few things though:
- Adding “positive” credit, such as secured credit cards and installment loans, to help offset the negatives on the credit report
- On-time payments on all remaining and recently acquired debt
- Low balances on credit cards that make up less than 25 percent of the credit limits
Myth #4: A bankruptcy will impact all consumers similarly, regardless of the amount of debt discharged or the number of debts included in the bankruptcy.
Fact #4: Not true, as certain credit scoring factors specifically evaluate the magnitude of the bankruptcy, such as the amount of debt discharged and the proportion of negative to positive accounts on the credit report. This means that a relatively low debt total spread over only a few accounts included in bankruptcy can lead to a higher post-bankruptcy score than one for which the scope of the bankruptcy is more extensive.
Myth #5: Any credit history associated with accounts included in bankruptcy will be removed from your credit report.
Fact #5: On the contrary, all of the bankruptcy-related history continues to appear on your credit report and is considered by the scoring formulas for the entire 7 to 10 post-bankruptcy years, though the negative impact diminishes over time.
So, before taking the big leap into bankruptcy, consult a bankruptcy attorney and learn the facts about how credit scores treat bankruptcy. You just may be able to minimize the damage and get a jump on re-establishing your credit after filing. If you want to know where your credit score stands following your bankruptcy, you can use a service like Credit.com’s Credit Report Card, which offers you a free credit score once a month.