What Will Filing Bankruptcy Do to My Credit?

This is probably the most common question I’m asked by my clients. Everyone is afraid of the big “B-word”, and rightfully so; filing bankruptcy is a big deal that certainly carries consequences of its own. Most people who end up filing would arguably say doing so was justified, otherwise faced with endless lawsuits and collections. But what effect does it have on one’s FICO credit score?

Many consider their credit score as the holy grail, at least in the context of one’s ability to obtain credit. And rightfully so. Among other criteria, lenders not only look at one’s FICO score, they look at the entire credit report. Needless to say, the higher the score, the better.

What people may not know is that a bankruptcy can actually serve to INCREASE your score, rather than decrease it. A large percentage of people who ultimately file bankruptcy have already taken substantial hits to their credit. Often enough, these debtors’ credit cards are near-maxed out, a phenomenon that can have drastic negative effects on their credit. A large portion of your credit score is determined by the ratio of debt to available credit on revolving accounts. As it passes 50%, one’s credit score begins to suffer. Once a debtor receives a discharge in bankruptcy, most if not all of the debt is eliminated, which can cause one’s score to increase, sometimes substantially.

Another factor to consider is the frequency of on-time payments. As a debtor begins to miss payments, these omissions negatively affect his or her credit score. If the debtor receives a discharge in bankruptcy but sought to reaffirm (continue paying) any particular secured debt (e.g., a mortgage or car loan), the incidence of on-time payments after the fact can serve to boost one’s score.

But, as most people know, if they file for bankruptcy, it’s certainly not kept a secret. A chapter 7 bankruptcy remains on one’s credit history for ten years from the date of filing (chapter 13 remains for seven years), visible to anyone who makes an inquiry. However, if you’ve received a discharge in bankruptcy, you may not receive a subsequent discharge for a significant period of time (if you’ve received a chapter 7 discharge, you may not receive another chapter 7 discharge for eight years from the date of filing, and may not receive a chapter 13 discharge for four years; if you’ve received a chapter 13 discharge, you may not receive another chapter 13 discharge for two years from the date of filing, and may not receive a chapter 7 discharge for six years). Lenders know this, and often welcome extension of credit to good faith filers who they know cannot seek to discharge that debt for some time.

Finally, banks are businesses. We as consumers are the source of that business. While individuals who have filed for bankruptcy may be seen as high-risk borrowers, they are also likely to have a propensity to consume. Whether or not such consumers would be subject to higher interest rates by virtue of a recent filing, they are nonetheless as good of candidates as anyone else.

Needless to say, the point of bankruptcy is not to fix your credit necessarily, nor is it encouraged to immediately obtain all kinds of credit following a discharge, but is certainly worth considering the long-term impacts of filing. In many cases, the effects are not as severe as perceived.