Bankruptcy will damage your credit. This is a fact and anyone who tells you otherwise is not telling you the truth. However, in many cases the damage to your credit due to bankruptcy will not be significantly worse than other negative credit events, and in some cases, you may find it easier to recover from bankruptcy more quickly than from other credit problems. Here’s why:
Credit bureaus – Equifax, Experian and Trans Union – are private companies that compile information about your credit performance for subscribers to the credit bureaus. Subscribers pay a fee to the credit bureaus for access to information. Most banks, credit card issuers, mortgage issuers, car lenders, etc. subscribe to one, two or all three credit bureaus.
Often, the information about your particular credit profile is delivered as a “credit score” – a number that lenders can use to compare your credit worthiness to that of others. Credit scores are calculated based on a number of factors – the exact factors and the weight assigned to each factor are trade secrets. We know generally how credit scores are calculated but not exactly.
Private creditors, such as rental property owners, small retail stores and local vendors usually do not find it cost effective to pay credit bureau subscription fees.
Federal Law Limits the Damage
Because credit reporting can have such significant implications, Congress got involved in the process and passed a law called the Fair Credit Reporting Act. This law sets out rules governing the behavior of the credit bureaus. These rules control everything from how long “derogatory” credit can stay on your credit report to the procedures for challenging inaccurate or outdated information.
Under the FCRA, derogatory information such as late pays, foreclosures and repossessions can remain on your credit reports for up to 7 years. A bankruptcy can remain on your credit for up to 10 years; however, a bankruptcy serves to discharge your debts. This means that when you exit bankruptcy – which happens about 5 months after filing for Chapter 7 and up to 5 years after filing for Chapter 13, you will be debt free.
To put this another way, if you were making credit decisions for a lender, who is a better risk – someone who filed bankruptcy within the past year and who cannot file again for 8 years thereafter, or someone who has not filed bankruptcy but who owes $60,000 in credit card debt and who could potentially file bankruptcy tomorrow?
You are a Better Credit Risk After Bankruptcy
In my experience, a debtor who has received his bankruptcy discharge is perceived by lenders as a better credit risk than someone who owes a lot of money but who has not yet filed. When I speak to my former clients, they tell me that within six months to a year after receiving their discharge, they are receiving credit card offers, and can qualify for car finance and even mortgage loans.
You will also find that your post-bankruptcy credit recovery will be easier if you file bankruptcy before you have multiple accounts in severe delinquency status. Realize that credit reports contain a lot of information about credit histories. If your report shows a bankruptcy plus multiple 90-day delinquencies, your credit will be damaged more than if your report shows a bankruptcy but few or no 90 day delinquencies.
Private debt repayment plans, by the way, will severely damage your credit because negotiated debt settlement will show up as a delinquent pay and for credit scoring algorithms, multiple late pays – especially 90 day late pays – are one of the worst marks you can have on your credit.
The big picture here – if you must file bankruptcy, choose the type of bankruptcy relief that will allow you to rebuild your credit life in such a way that you will not fall behind on your bills. If you use bankruptcy as a tool to clear out debt you cannot pay and you use the experience to pay your bills currently and live within your means, you will find that your credit profile will take care of itself.