Does Bankruptcy Ruin Credit?

Perhaps you are so overwhelmed by your monthly bills and past-due notices that you have considered filing for bankruptcy in the state of Florida. Of course, you probably have many important questions that you need solid answers before you make that decision. Myths abound regarding bankruptcy, and it can sometimes be difficult to get the information you require. One of the most pressing questions you may have centered around whether bankruptcy will ruin your credit, and, if so, for how long? There are other questions you probably have regarding the impact of bankruptcy on your current and future credit. Below, you will find the answers to some of those questions.

Is Credit and My Credit Report the Same Thing?

Most of us use to consider “credit,” “credit score,” and “credit report” to be roughly the same thing, however, there are important differences. Your actual credit is your ability to borrow money. This means that even though you may consistently pay your bills on time, every single month, if those bills far outweigh your monthly income, it is unlikely anyone will loan you money. This could also be true for your credit score. While you might have a decent credit score if you have a very high debt to income ratio, nobody will be knocking at your door to loan you money—and if you do get a loan, you will likely pay much higher interest rates than those with a lower debt to income ratio.

Your credit report actually lists your credit cards, mortgage, car loan, payment history, and any negative public records such as bankruptcy or foreclosure. Oddly enough, after your bankruptcy, your credit score may actually temporarily go up, because it will reflect your lower debt-to-income ratio. Some creditors may even consider you a better credit risk following your bankruptcy because you will—at least on paper—be able to afford your payments with most of your prior debt erased.

Will Bankruptcy Ruin My Credit?

So, now that you understand the differences between your credit, your credit report, and your credit score, will bankruptcy lower your credit score, and wreck your credit, making it impossible to ever get a loan again? The most widely-held belief is that filing for bankruptcy will ruin your credit for the rest of your life. This is simply not true, although it will definitely have a negative impact on your credit and credit score for at least a period of time. Under the Fair Credit Reporting Act, your bankruptcy will appear on your credit report for ten years. Any of the accounts which are discharged through bankruptcy will show on your credit report as “Included in Bankruptcy,” for a period of seven years. In the short term, bankruptcy will absolutely lower your credit score significantly and will prevent you from getting credit—at least on any kind of favorable terms.

In other words, you might be able to get a loan or a credit card soon after your bankruptcy, but the interest rate will likely be astronomical. About two years after your bankruptcy filing, you may be able to get closer to normal terms on a loan, and, over time, the negative effects of the bankruptcy will gradually diminish. In the long run, the effect of filing bankruptcy on your credit and credit score could well be the lesser of two evils when compared to default on all the accounts that bankruptcy discharged. The average FICO score in the U.S. is about 689. A person with a score of 680 will find that score lowered by anywhere from 130-150 points. A person with a higher credit score—say 780—will lose even more points after filing bankruptcy—between 220 and 240. The higher your credit score to being with, the more points you will lose.

What if I Already Had a Bad Credit Score?

Those who already have a bad credit score may wonder why they should worry about the effect bankruptcy will have on their credit. While the pros and cons must still be weighed, in fact you might want to be more worried if your credit score is already very low. This means your bankruptcy could drop your credit score into the 300-400 range—numbers which are very hard to recover from. When your credit score drops that low, few creditors will talk to you until your scores are back up in the high 500s or 600s. And getting back to that point can be a long, slow haul, so just because your credit is already bad, don’t think this makes it more acceptable to file for bankruptcy.

Will filing Chapter 13 Bankruptcy or Chapter 7 Bankruptcy Be Better for My Credit?

Most people believe that since you pay back your debts through Chapter 13 bankruptcy, it will affect your credit score much less negatively than filing Chapter 7 bankruptcy. In fact, both Chapter 7 and Chapter 13 bankruptcy stay on your credit report for about ten years. The only difference between the two, is that a creditor might be a bit more willing to overlook a poor credit score and lend you money if you filed for Chapter 13 bankruptcy rather than Chapter 7. Chapter 13 bankruptcy allows you to repay some or all of your debts over a three-five year period, while Chapter 7 bankruptcy forgives most of your debts without you paying them back. A lender, looking at your credit report might possibly decide you are more credit-worthy since you chose the more responsible way to handle your debt by making a good-faith effort to pay your creditors.

 

Could Bankruptcy Ever Actually Improve a Credit Score?

As noted, your credit score will likely go up immediately following your bankruptcy—then will tank within a month or so. Depending on your specific situation, in some instances, you could well end up with a better credit score within a few years than you had prior to the bankruptcy. Consider this: suppose you are behind on your payments with no light at the end of the tunnel, or already have accounts in collections. In this instance, you are better off filing bankruptcy, having the debts discharged, taking the hit, then working hard to build back your credit and improve your credit score. Bankruptcy can provide you with the kind of fresh financial start few other things can. When you resist filing bankruptcy, continue to make late payments, increase your debt-to-income ratio, and default on debts, your credit score will nosedive.

In the short-term, debt negotiation and debt consolidation are good options for about a month, and should only be used if you are expecting a windfall soon. By month six, one year and two years these options soon become terrible. Doing nothing (i.e., hiding your head in the sand and hoping it will all go away), will also soon become a terrible option. Repaying off and on is a so-so option. If you pay more often than you don’t, then you will take a hit on your credit score, however possibly not as bad in the beginning as you will file for bankruptcy. Filing for bankruptcy, however, is terrible for your credit score during the first six months, moving to the “so-so” credit score category by one year, the “decent” category by the second year, and potentially even the “good” category by the third year—assuming you have been supremely responsible with your credit and paying your bills on time during that time period.

Will I Be Able to Buy a Home After I file Bankruptcy?

Most consumers wonder whether they will ever be able to purchase a home following a bankruptcy filing. This is one instance where the type of bankruptcy you file could make a difference. If you file for Chapter 7 bankruptcy, you will typically wait at least four years to be able to qualify for a conventional loan and two years for FHA or VA financing. FHA offers a short-term “Back to Work” program for qualified buyers which could make the process even quicker. If you filed for Chapter 13 bankruptcy, you could be eligible for a conventional mortgage as soon as two years after the Chapter 13 discharge, with even more leniency through FHA and VA. If you can show at least one year’s worth of on-time payments, you may be eligible for a governmental home loan in as little as a year from the time you file for Chapter 13 bankruptcy—so long as you have permission from the court to take on this new debt.

Will I Be Able to Get Credit or a Car Loan After I File for Bankruptcy?

It is likely you will begin receiving credit card applications soon after your bankruptcy filing is complete. This is because your credit report looks—at least temporarily—much better than it did. Be very cautious when choosing credit cards. Make sure you choose the one with the lowest interest rate, and when you get the card use it very, very wisely. Each time you charge something, pay your bill in full as soon as it arrives. If you do this consistently for at least a couple of years, you will go a long way toward improving your credit score. If you need a car loan, make sure you have all the information before you go car shopping. Get the latest copy of your credit report and FICO score. If you paid your prior car loans on time, this will work in your favor. Have a good down payment before you look for a vehicle—this means your lender is taking less of a risk.

If you are planning to trade in your vehicle and have some other method of getting where you need to go, you can almost certainly get more money for your car than you will get as a trade-in. Some dealerships let you fill out an application online for preapproval. If this is possible, it could save you lots of time and potential embarrassment. Expect to pay a higher interest. Those with a credit score of 300-500 will pay somewhere around 14 percent interest for a new vehicle and 19 percent for a used one. Don’t assume a “buy here pay here” dealership will be your only option. In fact, such places should be your absolute last resort. The interest rate is likely ridiculously high—a fact you may not really register because they tend to quote the interest by the month rather than the year. Getting a really bad auto loan that you are unable to repay will not help your credit score, but will hurt it even more.

What are the Best Ways to Improve My Credit Score Following Bankruptcy?

Know going in that it will be a slow process to build your credit back up and improve your credit score. If you filed for Chapter 13 bankruptcy and have faithfully paid your creditors according to the court’s directions, you could potentially even refinance out of your Chapter 13 bankruptcy by two years. Even if you are unable to do that, after three to five years of living on a strict budge and managing your money efficiently, you should qualify for a regular mortgage or car loan. Try not to borrow too much or too quickly. Start a savings account and being putting money into every payday, no matter what. Since you have eliminated your debt, you are in a much better position to save some money.

If you can, save 10 percent of your income as an emergency reserve. Never, ever take out a payday loan or a car title loan. You could actually end up paying as much as 400 percent interest with these predatory lending scams. Watch your credit report and credit score closely, making sure to look for errors or inaccurate information. Consider a secured credit card. For a secured card, you will make a deposit into a secured account. The bank will then provide you with a credit line that is anywhere from 50-100% of your deposit. In the end, use credit sparingly and wisely, pay your bills on time, live within your budget, and make restoring your financial stability a priority in your life. If you have more questions and need help filing a Florida bankruptcy, speak to an experienced Florida bankruptcy attorney as soon as possible.