How Does Bankruptcy Affect My Credit?

Bankruptcy Lawyer Ventura, Oxnard, Camarillo, Thousand Oaks, Santa Paula, Fillmore

How Much Will Bankruptcy Hurt My Credit?

This is one of the first questions people ask in a bankruptcy consultation.

But, far from being the “credit killer” people perceive it to be, bankruptcy can actually be a powerful tool for quickly rebuilding your credit.

Here’s how.

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How Unsecured Debt and High Utilization Lowers Your Credit Score

The average person considering bankruptcy has a lot of unsecured (often credit card) debt.

For that matter, the average American has a lot of credit card debt.

Sometimes people call us for a debt lawsuit, and we ask how much credit card debt they have.

Often the reply is “but I’m paying it every month.” Sometimes this means they are paying monthly minimums. 

Many potential bankruptcy filers have done a good job making minimum payments for years and years. But, they start to see that the huge minimum payments are preventing them from saving for the things they really want in life– a house, college funds for their children, and retirement savings.

Once they accumulate a certain amount of unsecured debt, their FICO credit score takes a nosedive– even though they had never missed a payment.

This is because up to 40% of your FICO score is determined by (1) how much unsecured debt you have and (2) the percentage of your available credit you are using at any given time (called your “utilization rate.”)

More unsecured debt and higher utilization rates will give you a lower FICO score.

Why Your FICO Score Has Already Dropped

While making timely payments is good for a person’s credit score, the FICO scoring model isn’t crazy about people making only the minimum payment required.

FICO also hates to see credit card utilization above 50% of the total credit line (and it prefers that you keep utilization below 30%.)

So, even when you make your monthly payments, FICO is probably already penalizing you with a lower score if you carry high balances and pay only the minimum payment due each month.

Bankruptcy’s “Reset Button” Helps You Rebuild Credit

A typical Chapter 7 bankruptcy filer has about $50,000.00 in credit card debt at an average interest rate is 18.75%. Their monthly minimum payments are usually around $1000.00.

It would take this person 99 months to pay off the credit card debt if they were making minimum payments of $1000.00 / month.

For the first several years of this hypothetical payment plan, the person wouldn’t be making a dent in the principal debt balance. Their FICO score would remain low due to (likely) high utilization rate and the fact they are making only minimum payments. 

But, there is another way.

Your FICO Score During Bankruptcy

In our office, the average person filing bankruptcy sees a FICO credit score drop of 30-70 points in the month he or she files Chapter 7 bankruptcy.

When they receive their bankruptcy discharge three to four months after filing (for an average Chapter 7 case), the bankruptcy filer’s FICO score goes back up 40-100 points, on average.

The score goes up a bit upon discharge because the bankruptcy filer has become that rare creature known as a “debt free person.”

While the FICO scoring model is not overjoyed about how you got there (using bankruptcy), the model does give you some points for wiping out the debts.

Your credit score will continue to go up post-bankruptcy as you rebuild your credit.

Around the one year anniversary of the bankruptcy filing date, the average bankruptcy filer’s FICO score is 100-200 points higher than it was before they filed bankruptcy. (This assumes the person keeps all post-bankruptcy accounts like car payment and utilities in good standing.)

And you can do it in about a year.

Sure, there is a temporary “dip” in the credit score during the 3-4 months you are completing your bankruptcy before receiving your discharge. But, that is a small price to pay for wiping out your debts and seeing the large FICO gains in about one years’ time.

But Won’t Bankruptcy Stay on My Credit Report for Ten Years?

It is true that a Chapter 7 bankruptcy can remain on your credit report for up to 10 years after your bankruptcy filing date. A Chapter 13 filing can be reported for up to seven years after your filing date.

This could be an issue if a potential creditor has a firm policy against lending to anyone with a bankruptcy in their credit history.

Many large institutional lenders might never even see your actual credit report– many only review your FICO credit score when deciding whether to do business with you. These lenders might be more open to lending to a person with a recent bankruptcy.

The Tradeoff of Bankruptcy

A Chapter 7 bankruptcy can make you a debt-free person very quickly.

The tradeoff is:

  • You might have to wait up to a year from your bankruptcy filing date to see a large increase in your FICO score and
  • The bankruptcy event itself can remain on your credit for up to ten years, which can be an issue for lenders who review your actual credit report and not just your FICO credit score.

The upside is, of course, becoming a debt free person in four months instead of years and years of making huge “minimum” payments.

A pretty big upside, if you think about it.

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***Now for the disclaimers: a person’s FICO score is determined by his or her entire credit history and is therefore highly individual. So, it’s difficult to predict exactly what effect any one event will have on a person’s FICO score. The point ranges discussed above are averages based on our clients’ (average bankruptcy filers) experiences over the years.***