Whether you’re contemplating bankruptcy or have a bankruptcy in your past and are concerned about its impact on your credit, it can be very difficult to separate myth from fact. In part, that’s because both bankruptcy and credit management can be stressful, increasing the tendency to believe the worst-case scenario. In addition, much of the mythology surrounding bankruptcy and credit is partially true or has some basis in fact.
While every situation is different, here is some fact-based information about bankruptcy and credit to help dispel the myths.
Does Bankruptcy Ruin Your Credit?
A bankruptcy will not always “ruin” your credit. A bankruptcy is a negative entry for purposes of calculating your credit score, so it’s easy to believe that bankruptcy will destroy your credit. Tidbits of information taken out of context seem to support that view. Notably, a few years back the Fair Isaac Corporation (FICO) published a breakdown of how a variety of different events would impact the credit scores of two fictional people.
The headline takeaway from this study for many blogs and publications was “bankruptcy could drop your credit score by hundreds of points!” The information seemed to be coming straight from the horse’s mouth: Fair Isaac creates the algorithms used to calculate credit scores. That quick fact is still in circulation today, but with a lot of detail missing.
The first hypothetical person whose credit score dropped by hundreds of points in the Fair Isaac posting started out with a score of 780. Another profile, with a starting score of 680, saw a still-significant but far less dramatic impact. And, while Fair Isaac does still say that a credit score in the 700s could drop 100 points or more after bankruptcy, bankruptcy has been removed from the list of events the company currently models in its credit impact materials.
Of course, most people contemplating bankruptcy don’t have 780 credit scores–most have struggled for a while before resorting to bankruptcy, juggling debts and running up credit card balances in an effort to regain control of their finances. Among consumers studied for a 2014 report from the Federal Reserve bank of Philadelphia, average pre-filing credit scores were 538.2 for Chapter 7 petitioners and 535.2 for those filing Chapter 13 bankruptcy. On average, those low-scoring bankruptcy filers saw a significant improvement in their credit scores shortly after discharge: about 75 points for Chapter 13 filers and about 82 points for those receiving discharges in Chapter 7 bankruptcy.
Online lending broker LendingTree studied more than 1,000,000 accounts in 2017, and determined that more than ⅔ of their customers who had filed bankruptcy had credit scores of 640 or higher within two years post-bankruptcy. More than 40% hit that mark within a year. The report concluded that people rebuilding credit after bankruptcy were in a similar position to those rebuilding credit for other reasons, and in some cases were better positioned to do so because of their low debt burdens.
In short, the impact of a bankruptcy filing and discharge varies depending on a variety of factors. For some, credit scores will rise with the discharge of delinquent debt.
Of course, one of the most significant variables impacting credit after bankruptcy is the decisions you make as you rebuild your finances.
Protecting and Improving Credit after Bankruptcy
There are two important ways you can positively impact your credit report and credit score after bankruptcy. The first is obvious, at least in concept: the way you manage your credit and other debts after bankruptcy can have a tremendous impact on how quickly your credit recovers–or doesn’t.
While some pieces of this puzzle are readily apparent–for instance, you undoubtedly know that it’s important to make payments on time moving forward–not all are common sense. For instance, many people don’t realize that using a substantial portion of their available credit can have a significant negative impact on credit scores, even when credit cards are in good standing and all payments have been made on time.
While the precise algorithms that determine credit scores are secret, Fair Isaac and all three major credit reporting agencies make information available about the types of information that impact your credit score and the relative weight given to each.
Monitoring Credit after Bankruptcy
In addition to making payments on time, keeping credit utilization low and attending to all of the other factors that impact credit scores generally, people who have filed for bankruptcy must also monitor their credit report to ensure that they are receiving the full benefit of the bankruptcy discharge.
Once a debt has been included in or discharged in bankruptcy, it should be labeled as such on your credit report. Unfortunately, debts that have been discharged in bankruptcy sometimes continue to appear as delinquent debt on credit reports, or reappear after a few months. This creates a worst of both worlds situation, in which your credit history shows both a bankruptcy filing and outstanding delinquent debt.
Sometimes this is an innocent mistake, but in other cases, unscrupulous creditors or debt collectors continue reporting the debt as delinquent in hopes of pressuring consumers to pay discharged debt. Another scenario is that the original creditor sells the discharged debt to a debt buyer, who reports it as a new collection account. To get the full advantage of a bankruptcy discharge and effectively rebuild credit after bankruptcy, it is important to pay close attention to credit reports and to promptly dispute any discharged items that are being reported improperly.
You can get a free copy of your credit report from each of the three major credit bureaus once a year by visiting www.annualcreditreport.com or contacting TransUnion, Equifax and Experian directly.
The bottom line is that you have tremendous power to impact what happens to your credit score after bankruptcy–in some cases, significantly more power than you have while juggling past-due balances.
Kathryn Davis is an attorney at the Bond & Botes Law Offices in Huntsville and Decatur, Alabama. She holds a Bachelor of Arts from Auburn University, and a Juris Doctorate from Samford University, Cumberland School of Law. She is passionate about utilizing the bankruptcy process to help clients navigate through what is usually some of the lowest points in their lives. Read her full bio here.