- Bankruptcy allows borrowers to get a fresh start on their debts, either by setting up a payment plan or by liquidating their assets.
- Depending on the type of bankruptcy—Chapter 7 or Chapter 13—it may stay on your credit report for seven to 10 years.
- Having a bankruptcy on your credit report can make it difficult to borrow money or access the best interest rates.
- The worst effects of bankruptcy will begin to wear off after a couple of years, at which point you can start rebuilding your credit.
From Walt Disney to Henry Ford, people have been getting in over their heads and filing for bankruptcy for hundreds of years.
Bankruptcy allows you to get a fresh start on your finances, eliminating all or much of your debt. However, it has a major impact on your credit and can hold you back financially in other areas for several years, so it’s a step to be taken with much consideration.
We’ll examine how bankruptcy works, how long its stays on your credit report and what the impacts can be.
Inside this article
How does bankruptcy work?
Bankruptcy is a legal process that involves a judge and, often, a court trustee. A judge oversees the proceedings and a court trustee is assigned to help examine your assets and liabilities and liquidate certain assets to cover your debt.
The goal of bankruptcy is to give borrowers a fresh start. While it damages their credit for many years, it can help eliminate your debt burdens—or at least many of them—so you can get back on your feet financially.
There are two different kinds of bankruptcies and they each have different impacts on your credit report.
Chapter 7 bankruptcy
Chapter 7 is the most common type of bankruptcy and what most people likely think of when they hear the term. Also known as “straight bankruptcy,” Chapter 7 is when you work with a court trustee to liquidate your assets to cover as much of your debt as possible.
Certain assets are exempt from Chapter 7 bankruptcy, including your home, certain retirement assets and items needed for your employment. All assets that aren’t exempt are liquidated (essentially, sold off) in the bankruptcy process, and the proceeds go to pay off your debt. Any debt that can’t be paid off with your assets is then discharged, meaning you no longer have to worry about it.
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Unfortunately, Chapter 7 bankruptcy can’t eliminate all of your debt.
For example, your student loans, court-ordered child support or alimony and taxes will remain. Additionally, if you have a home, you’ll still have to continue your mortgage payments or you may risk losing it.
Chapter 13 bankruptcy
Chapter 13 bankruptcy is also known as a reorganization of your finances because rather than liquidating your assets and discharging your debts, it involves creating a manageable payment plan while allowing you to keep your assets.
This type of bankruptcy may be less desirable for some borrowers since it still requires you to make payments on your debt for several more years instead of wiping it out. However, you may be motivated to go this route since you’ll be able to keep non-exempt assets, like property.
How bankruptcy affects your credit
Bankruptcy is usually considered a last resort for debt relief, largely because of the negative impact it has on your credit.
Depending on your credit score when you file for bankruptcy, you can expect to lose anywhere from 100 to 250 points from your score. The higher your credit score was to begin with, the more points you’ll lose.
Aside from the number of points you’ll lose on your credit score, you’ll also have the mark of bankruptcy on your credit report.
“More important is the implicit bias,” says Josh Richner, marketing and outreach coordinator with National Legal Center, a civil practice law firm based in Candia, New Hampshire. “A bankruptcy is likely to influence a lender’s decision even if the credit score qualifies the borrower for the loan.”
Once you have a bankruptcy on your credit report, especially if it’s fairly recent, you’re likely to have a hard time accessing new credit. As a result, you may not be able to obtain a credit card, borrow money for a car or take out loans for any other purpose.
Unfortunately, your credit can also hold you back in other ways.
For example, landlords look at your credit when deciding whether to rent you an apartment. Similarly, car insurance companies use your credit score as a determining factor when setting insurance rates.
Even once your credit has bounced back enough to allow you to access new credit, you can expect to have access to less favorable borrowing terms than you may have had before the bankruptcy. For example, you’ll probably be offered higher interest rates and may need a larger down payment to buy a home or a car.
How long does bankruptcy stay on your credit report?
The effects can be long-lasting, and depend upon the type of bankruptcy you file.
“There is not likely to be a difference between Chapter 7 and Chapter 13 bankruptcy as far as the impact on a credit score is concerned, but there will be from a time perspective,” Richner says.
A Chapter 7 bankruptcy will remain on your credit report for up to 10 years from the date you initially filed. In the case of a Chapter 13 bankruptcy, it’s likely to remain on your credit report for seven years.
The good news is that the negative effect on your credit score and ability to borrow won’t be felt as strongly the entire time the bankruptcy is on your credit report. You’ll feel the greatest impact of the bankruptcy for the first few years after filing. After that, however, you may be able to access credit more easily.
How to rebuild your credit after bankruptcy
If you’ve filed for bankruptcy, especially in the past couple of years, then you’re likely struggling with the negative impact it’s had on your credit score. The good news is the negative impact isn’t permanent, and there are steps you can take to rebuild your credit.
“Rebuilding credit after bankruptcy is entirely possible with a bit of consistency and determination,” Richner says.
The simplest thing you can do to rebuild your credit after bankruptcy is to use money and credit responsibly. Make all of your monthly payments on time. Whether it’s the payment on a credit card or a utility bill, a late payment will appear on your credit and cause another drop in your credit score.
Another way to help rebuild your credit and avoid another disaster is to build an emergency fund. The emergency fund won’t directly increase your credit score, but it will ensure that your credit will be better protected if you run into a financial emergency. Rather than racking up additional credit card debt or loans, you’ll have the emergency funds to fall back on.
The final step is to show lenders that you can use credit responsibly. Start by applying for a secured credit card, which is specifically designed for borrowers with poor credit. As you use the card and pay it off each month, your credit will increase. Eventually, you can be upgraded to a non-secured card.
Alternatives to filing for bankruptcy
As we mentioned, bankruptcy is usually the last resort in debt relief because of the impact it has on your finances. If your debt is becoming unmanageable, there are other steps you can take first.
First off, speak to a financial professional trained in these situations. Whether it’s a financial coach, a financial advisor or a credit counselor, the right person can help you see solutions that aren’t obvious to you and address the financial habits that got you into debt in the first place.
Another alternative to consider is debt consolidation. This type of debt relief is popular for those with credit card debt. It allows you to consolidate multiple high-interest debts into a single personal loan with just one monthly payment. You can often lower your interest rate, making your payments more manageable.
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There’s also debt settlement, in which you negotiate your debts on your own or with a debt relief company. You end up paying less than what you owe, in a lump sum or short series of payments, Richner says.
While most debt relief options will make a dent on your credit report, bankruptcy is the most dramatic of them. Talk to a financial professional if you need further help in deciding what’s right for you.