How does bankruptcy affect your credit?
Before we can discuss how bankruptcy affects your credit, we have to know what we’re talking about:
Credit is your ability to borrow money, typically from banks. Your Credit Score is the magic number that tells people how good you are at borrowing money and paying it back, and generally equates to how easy it will be for you to get a loan.
Bankruptcy is when you can’t pay off your debts. There’s two primary forms of bankruptcy, called Chapter 7 Bankruptcy and Chapter 13 Bankruptcy. If you file for Chapter 7, the people you owe money to can take and sell some of your things to try and get as much money as they can to pay them back. If you file for Chapter 13, you keep all your stuff and you work out a payment plan to make it more possible to pay off your debts.
If you pay all of your bills on time and have borrowed and paid off some loans, you should have a relatively high credit score and be able to borrow money easily to buy a car or home or get a credit card. If you’ve never borrowed money before, or you’re frequently late with payments, your credit score will be lower and you’ll have a hard time buying anything.
If you have a steady job and just need to rearrange your debts to make them easier to pay off, Chapter 13 would be your most likely course of action. If you have hit hard financial times and absolutely cannot hope to pay off your debts, you’ll qualify for Chapter 7 and much of your debt will simply be wiped away.
How do bankruptcy and credit work together?
It is a delicate dance, between Credit and Bankruptcy; most people think that a bankruptcy declaration will send their credit score plummeting, and they’re right…but it will also recover quite quickly, and typically go higher than before.
For example, one aspect of a credit score is your Debt to Income Ratio, or DTI. If you owe a lot of money (debt) and make very little money (income), you will have a poor DTI and your credit score will suffer. Bankruptcy clears away that debt, which automatically improves your DTI and will raise your credit score.
Bankruptcies in general, however, are a black mark on your credit score…but only temporarily. Credit records only last for seven years on inactive accounts (things you’re not currently paying or working with), so if you do declare bankruptcy, it will eventually drop off and your score will automatically go up. On top of that, the lower your credit score, the less a bankruptcy will affect you (a credit score of 700+ will go down by 200 points or more because of a bankruptcy, but a credit score of, say, 650 will only go down by 130 to 150 points).
What does this mean for you?
Bankruptcies should always be considered a last resort. If you find yourself in financial trouble, tap every resource you have to try and find a way through it. Oftentimes you can call your creditors and see if they’ll work out a payment plan or even settle the debt for a lower amount. It is important to take responsibility and show a willingness to work with the lender. They’ll appreciate your efforts, and typically do as much as they can for you.
But in these volatile financial times it is all too possible to become overwhelmed. Unexpected medical costs, a shift in employment, a family emergency…these can cause an incredible burden to be laid upon you, and there’s no shame in reaching the end of your rope and simply letting go. Bankruptcy attorneys are there to help you, the consumer, get back on your feet and back to earning and borrowing once again, so don’t hesitate to reach out for more information.
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