When consumers or businesses cannot repay their debts, they can enter into a federal court process meant to erase that debt or return the money under a bankruptcy court’s protection. Essentially a state of financial ruin or insolvency, bankruptcy is mainly caused by sudden large expenses or changes in income, such as becoming unemployed, having to pay a large medical fee, and other unexpected disasters like a house fire. Uncontrolled spending on a credit card is another common cause.
Bankruptcy can negatively impact a person’s financial well-being in a number of ways, especially the credit score. Thus, if you go bankrupt, knowing how bankruptcy impacts the credit score can enable you to understand the steps necessary to get your score back up to a respectable status.
Bankruptcy Impacts Everyone’s Credit Score Differently
The magnitude of debt plays a large role in how many points are deducted from the credit score by filing for bankruptcy. Declaring bankruptcy when you only have $6,000 in bills is going to have much less of an impact than if you had $20,000 in bills. If you know debt is piling up and you simply can’t pay it back, it may be better for your credit score to declare bankruptcy before the amount owed grows even larger from interest. Do be aware that you will have to show your inability to repay that debt via income statements and other information.
Bankruptcy Has a Lengthy Influence on Your Credit Score
Bankruptcy will stay on your credit report for seven years, with the level of impact decreasing over time. Note that a Chapter 7 bankruptcy’s public record lasts for 10 years on the credit report; this is the liquidation of non-exempt assets to pay back the debtor. Additionally, you can work to build your credit to numbers as high as 700 or more by making smart financial moves throughout this time, such as using secured credit cards, making on-time payments with new debt, and keeping low account balances,
Bankruptcy Is Worse than Foreclosure or Other Financial Disaster
Research has shown that bankruptcy impacts the credit score slightly worse than going into a foreclosure and much more than doing a short sale on a home. Overall, bankruptcy decreases the credit score 160 to 200 points. Thus, it’s usually better to try a short sale first if you have a property for which you can’t make the mortgage payments. Then, foreclosure is typically the preferable option to bankruptcy.
Increasing Your Credit Score Post-Bankruptcy
It’s important to know that bankruptcy is not a death sentence for your credit score. By monitoring your credit score, applying for credit soon after bankruptcy (car loans, store credit cards and secured credit cards are usually best), and then making on-time payments is going to help. Also, note that length of credit history accounts for 15 percent of your score, so keep older accounts alive and in good standing. Here are some more tips on fixing your credit score.