Credit Availability and Credit Scores After Bankruptcy

Many people who file for bankruptcy, or contemplate it, often wonder how much their credit score will decline because of the bankruptcy, and how soon they will be able to obtain new credit. The answer will largely depend on what chapter of bankruptcy you file under. For most people, it's either Chapter 7 or Chapter 13. However, let's first examine the effect of bankruptcy itself on credit scores and credit availability.

Credit Scores

According to this article, Credit Missteps, at myFICO.com, which is maintained by Fair Isaacs Corporation, the company that developed the credit score algorithm used by most lenders, bankruptcy lowers credit scores to the 500 range. It demonstrates how much bankruptcy lowers credit scores by using 2 hypothetical consumers, one with a credit score of 780 and the other with a credit score of 680 before filing for bankruptcy. The 780 score is reduced to 540-560 by the bankruptcy and the 680 score is reduced to 530-550. This also illustrates the fact that the higher the initial credit score, the more it is reduced by negative credit events.

However, even though bankruptcy lowers credit scores, it probably won't lower your score much more than it already is if you are in the dire financial straits where bankruptcy is your best alternative. Even if you were not yet late in any payments, if you cannot continue making payments then your credit score will suffer anyway. Hence, the effect of bankruptcy on credit scores is really irrelevant. What is relevant is that bankruptcy will help considerably in bettering your financial position by lowering or eliminating your debts, which, in turn, will better your credit score over time.

Credit scores are based on your financial history in the last 2 years, with more recent data having more weight in computing the score. Hence, by using credit wisely after bankruptcy, you can quickly raise your score significantly in as little as 1 year after bankruptcy.

However, to raise your credit score, you need new credit and that you will not get while you are in bankruptcy, and here is where the different chapters of bankruptcy differ significantly.

Chapter 7 and the Rehabilitative Bankruptcies

It has often been published and what many people think, especially those in Congress, is that filing under Chapter 13 or one of the other rehabilitative chapters of bankruptcy—Chapter 11 and 12—is better for your credit and therefore your credit score. However, this doesn't reflect how the credit scoring system works.

First, you will not get new credit until you receive a discharge of your prior debts—without that discharge, you would be a significant risk to any new lenders since they will not know your debt load until you have actually received a discharge of your debts. However, the rehabilitative bankruptcies require that you pay your past creditors with future income. Under Chapter 13, which is the most common rehabilitative chapter, you must pay your creditors for 3 years if your income is below the state median or for 5 years if it is above. You will not receive a discharge until your payment plan is completed and it must last for the specified time. You can receive a discharge sooner by either paying your creditors 100% of their debt or by obtaining a hardship discharge, which will only be granted under special circumstances. For instance, you have been disabled and it is not likely that you will get better during the pendency of your bankruptcy.

Under Chapter 7, your nonexempt, valuable assets are sold to pay creditors. All income earned after your bankruptcy filing date is yours to keep. The process of Chapter 7 takes 4 to 6 months, after which you receive a discharge, provided that your case is not dismissed before the discharge, as can happen if you were dishonest in your bankruptcy petition, for instance, or if you fail the means test, in which case, you will have to file under Chapter 13 or risk having your case dismissed under the presumption of abuse. This is why most people with no significant assets choose Chapter 7 over Chapter 13. Since you receive a discharge much sooner, you can re-establish credit sooner, and if you get new credit and pay your bills on time, your credit score will increase, especially if you do not incur debts that are a significant portion of your credit line—in other words, you keep your credit utilization low.

Getting New Credit After Bankruptcy

A bankruptcy discharge makes you a better credit risk because your prior nonpriority debts are discharged and because you are restricted from filing for bankruptcy again. Henceforth, your risk will be determined by your income and by the amount of priority debts you have that are not dischargeable. If you have a good amount of income over your expenses, then you should easily be able to re-establish credit. You also need a checking account and it would also help to have a savings account. A savings account doesn't affect your credit score, but lenders look at other things that will lower the risk of default and a savings account is one such thing, since it provides a cushion for emergencies. Another thing that may help is to agree to online statements, since this lowers the lender's cost of doing business with you, and online bill pay can help ensure that you make timely payments.

Don't try to establish new credit by applying for credit, since this lowers your credit score—the more you apply for credit, the lower your credit score, and the less likely that you will get credit. What to do in the meantime? Pay cash or use a debit card.

You can also apply for secured credit cards, where you have to deposit a minimum amount in a savings account. But because there are companies that are willing to extend credit to those with lower credit scores, simply wait until you get credit offers. There are banks that offer credit to recent bankrupts that don't even require a security deposit. Some will try to charge you onerous fees, where the fees will consume more than half of the credit that they offer.

Avoid them!

Part of being a smart consumer is to know when you are being ripped off! Others will offer you limited credit for a reasonable annual fee—this is usually a good offer. You can't expect to get a 1st credit card with no fees, so a low annual fee is good. Besides, in the current credit environment, it will be harder for many people to get credit cards without an annual fee. The Credit Card Act of 2009 has greatly restricted lender's ability to rip off consumers, but you still must be vigilant.

If you do want to apply for credit, then choose a credit provider that is willing to lend to people with lower credit scores. Capital One, for instance, is a major lender to people with lower credit scores. Some lenders, like American Express, won't lend to you as long as you have a bankruptcy in your credit record, so don't waste your time or lower your credit score by applying for an American Express card. One of the best ways to find out about your best possibilities is to go to online forums that cover consumer credit. This way you can find out about different lenders without applying for credit and risk being rejected, where each rejection will lower your credit score for 1 year after your application was rejected.

You can find many forums by searching for "forums credit cards". Many of the listings are dated, so be sure that you are reading current posts.

So how long does bankruptcy stay on your credit report?

Bankruptcy Listings in Credit Reports

A Chapter 7 bankruptcy can be listed in credit reports for up to 10 years from the bankruptcy filing date, and a Chapter 13 bankruptcy can be listed for up to 7 years after filing. Note that because a Chapter 13 case usually takes about 3 to 5 years from filing to discharge, a Chapter 13 bankruptcy can only be listed in credit reports for about 2 to 4 more years after the final discharge.

Another advantage of bankruptcy is that it places a definite time limit on defaulted accounts. In other words, a delinquent credit card account will be listed in credit reports for up to 7 years after the account is closed! If the account is never closed, then it can remain on the credit report indefinitely. Bankruptcy puts a definite limit on how long discharged accounts can remain in the file.

Bankruptcy Dismissal

Some people seek to dismiss their bankruptcy case under the mistaken belief that it will improve their credit history. It won't! The bankruptcy filing goes on your credit report, not the discharge. In fact, your credit history will be better if you get a discharge, because your discharged debts listed on your credit report must be listed as discharged—this lowers, or eliminates, your overall debt, which will lower your credit risk.

Checking Your Credit Reports

Since credit scores are calculated based on information in your credit reports, it is important that you ensure that your reports have accurate information. After receiving a discharge of your debts, you should check all 3 credit reports to make sure that your discharged debts are listed as such in your credit report.

You can get your credit reports free of charge at AnnualCreditReport.com, which is a centralized service for consumers to request free credit reports (aka credit file disclosures). It was created by the 3 nationwide consumer credit reporting companies, Equifax, Experian and TransUnion. Under the Fair and Accurate Credit Transactions Act (FACT Act or FACTA) consumers can request and obtain a free credit report once every 12 months from each company. You can also dispute credit information at this secure site. If you live in California, Colorado, Connecticut, Georgia, Maine, Maryland, Massachusetts, Minnesota, Montana, New Jersey, Vermont or the Virgin Islands, you are entitled to at least 1 more free copy from each credit bureau per year. If you are rejected for credit because of information in your credit report, the lender must notify you which credit report was used in their decision, then you have a right to receive a free copy of that report because of the rejection, which won't count as one of your free credit reports.

Tip! Get a free credit report every 4 months by requesting a report from only 1 credit reporting agency at a time—a good, free way to monitor your credit report. However, if you have recently received a bankruptcy discharge, then check all 3 at least a month after you receive your discharge. (You want to wait at least a month until the credit files are updated.)