UPDATE: Article Updated by Brian Acton 3/7/18
Filing for bankruptcy is devastating to your credit and can cause your credit score to plummet more than 200 points. But for people in dire straits, bankruptcy is a last resort that can help them liquidate assets, discard or pay off debts, and get some financial relief.
If you’re considering bankruptcy, you need to understand how it will affect your credit. This involves clearing up some common misconceptions about how bankruptcy affects your credit.
Myth #1: If you don’t have negative information on your credit report prior to bankruptcy, you will have a higher post-bankruptcy credit score than if your report contained negative information prior to filing.
The Truth: Positive payment history and a lack of negative information does very little to minimize the impact of a bankruptcy on your credit score. The presence of a bankruptcy, and the length of time the bankruptcy has been on your report, are the strongest determining factors.
Myth #2: All bankruptcy information stays on your credit report for ten years, without exception.
The Truth: Only the public record of a Chapter 7 bankruptcy lasts for ten years. All other bankruptcy references remain on your credit report for seven years, including:
- Trade lines that state “account included in bankruptcy”
- Third-party collection debts, judgments and tax liens discharged through bankruptcy
- Chapter 13 public record items
Once the above items start disappearing, you may see a bigger boost in your credit score.
Myth #3: You will have poor credit as long as the bankruptcy information stays on your credit report.
The Truth: While you should expect a dramatically lower credit score following bankruptcy, you can begin to build your credit back up with smart credit management. After four or five years, you may even be able to crack the good credit score range (700-749). Following bankruptcy, you can immediately begin to build your credit back up by:
- Adding new credit, such as secured credit cards or small installment loans, to offset the negative information on your credit report
- Making on-time payments for all debt, new and old
- Keeping your credit card balances under 30% utilization
Myth #4: Bankruptcy affects the credit of all consumers equally, regardless of the amount of debt or the number of debts included.
The Truth: Your credit score will factor in details such as the amount of debt discharged and the proportion of negative to positive accounts on your credit report. If you have a relatively low amount of debt and only a few accounts included in your bankruptcy, your credit score will be higher than someone with a more severe bankruptcy.
Myth #5: All bankruptcy debts will be wiped clean from your credit report.
The Truth: While bankruptcy may help you erase or pay off past debts, those accounts will not disappear from your credit report. All bankruptcy-related accounts will remain on your credit report and affect your credit score for seven to ten years, although their impact will lessen over time.
Also, federal student loans often can’t be discharged in bankruptcy, so you may still be on the hook for those.
Myth #6: You can’t get a credit card or loan after bankruptcy.
The Truth: Credit cards are one of the best ways to build credit, and there are options out there for those with a checkered credit history. Secured credit cards, which require an upfront security deposit, have a lower barrier of entry but spend and build credit just like a traditional card.
Similarly, there are loans available – such as passbook, CD or credit builder loans – that are secured with a deposit or collateral and will help you build credit as you pay them off. Like secured credit cards, these loans are much easier to come by because the lender is protected in the event you can’t pay.
Myth # 7: Bankruptcy will ruin your credit forever.
The Truth: Bankruptcy will do severe damage to your credit in the short term, but it will only stay on your credit report for a maximum of ten years. After that, you’re free and clear. And if you continue to practice good financial habits and build credit in the meantime, you can rebuild your credit to be stronger than ever
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.