How Does a Bankruptcy Impact Your Credit Score?

The following is presented for informational purposes only and should not be construed as legal advice or credit repair. 

Declaring bankruptcy may be a path forward if your bills are piling up faster than you can pay them, or life events leave you without an income. You may be worried about the ramifications on your credit, and rightly so. Regardless of the type of bankruptcy you declare, it will likely have a considerably negative impact on your credit. 

Consider that consumer credit scores are generally intended to help lenders determine the likelihood that you’ll make a debt payment within 90 days. A bankruptcy tells lenders that not only did you go over 90 days, you weren’t ever able to pay the entirety of what you owed. 

According to FICO, the creator of the widely used FICO credit scores, if you currently have a very good FICO score, you can expect to see a "huge drop" in your score drop if you declare bankruptcy.

If your score is already low, perhaps due to high credit card balances or late payments, it may not drop by as many points since the bankruptcy is just an additional derogatory mark on an already checkered credit report. In some cases, the bankruptcy might even increase your score if it discharges high balances on your accounts. However, your score may still be quite low, and the bankruptcy could affect your overall creditworthiness and ability to get credit regardless of your score. 

The type of bankruptcy you file makes a difference

If you decide to declare bankruptcy, you may have several options to choose from. You should consult with a bankruptcy attorney to understand the pros and cons of each, and if you decide to move forward with a bankruptcy, you may need to sign up for bankruptcy counseling through a nonprofit credit counseling organization. 

Chapter 7 vs. Chapter 13

Two of the most common types of consumer bankruptcies are Chapter 7 and Chapter 13 bankruptcies. With a Chapter 13 bankruptcy, you will repay a portion of your debts with a repayment plan. A Chapter 7 could completely wipe out your unsecured debts. From a credit perspective, the primary difference between the type of bankruptcy you declare is how long it could take for the bankruptcy to get removed from your credit reports: 

• Bankruptcy filings, including Chapter 7 bankruptcies, must be removed from your credit reports 10 years after the filing date. 
• However, credit agencies generally remove a Chapter 13 bankruptcy filing seven years after the filing date if you complete the repayment plan or the debt is discharged. If you don’t complete the plan and the debt isn’t discharged, the Chapter 13 bankruptcy may remain for up to 10 years. 

The credit reporting agencies may add new codes to the accounts that are affected by your bankruptcy to indicate that they were part of a bankruptcy, the type of bankruptcy, and what happened to the debt (e.g. it was discharged or dismissed). 

The affected accounts may actually fall off your credit reports before the bankruptcy does. For example, a past-due account with a history of late payments has to be removed from your reports seven years after the first delinquency on the account, which could have been months or years before the bankruptcy. If you have an account in collections, the seven-year period starts with your first late payment, not when the account was sent or sold to the collection agency. Even if you close accounts that were otherwise in good standing as a result of the bankruptcy, they should be removed seven years after the closure. 

Recovering from a bankruptcy 

You’re likely dealing with a multitude of financial, and perhaps personal, problems immediately before and after a bankruptcy. You may want to start by focusing on those, and when you’ve got a little breathing room, you can start taking steps to improve your credit as well. 

In fact, even if you somehow magically got your credit score to jump up to a perfect 850 in a month, the bankruptcy could still affect your creditworthiness. A credit score is just one factor that creditors consider when reviewing your application and underwriting a loan or credit account. In some cases, regardless of your credit score, you may be automatically rejected for a credit card application if you’ve had a bankruptcy within the last couple of years.

Steps to rebuild your credit

However, starting to rebuild your credit as soon as possible could help your credit recover from a bankruptcy more quickly. One of the most important things could be starting to add new on-time payments to your credit reports. To do so, you may need take out a loan or open a credit card that reports your payments to the credit bureaus. 

Secured credit cards and credit-builder loans, the same financial products that some people turn to when trying to build credit for the first time, may be helpful options. In either case, you give the lender a refundable security deposit that it can keep if you default on the account (it’s not intended to cover your monthly payments). A secured credit card’s credit limit will be equal to your security deposit, and you could make a small purchase each month and then pay it off in full to start building a positive credit history. With a credit-builder loan, you receive a loan equal to your security deposit and make monthly payments — when you pay off the loan, you get your security deposit back. 

While a bankruptcy could hurt your credit more than any other type of derogatory mark, know that you can recover. Even though the bankruptcy could stay on you report for up to 10 years, the impact can decrease over time and taking steps to build positive credit could speed up your recovery.

If you're considering bankruptcy, but aren't sure if there are better options available, consider working with a credit counselor first. Counseling if free and can help you understand the severity of your situation, while providing useful, concrete next steps on whichever path you choose. Get started anytime, online or over the phone.