How Bankruptcy May Improve Your Credit Score
Filing for bankruptcy protection is not an easy decision to make. There are many concerns that come to mind when thinking about how bankruptcy will affect your life, and chief among them is the worry that your credit rating will be so damaged, you won’t be able to secure any type of credit, even at terrible rates, ever again.
But here’s some interesting information – in many cases, the damage to your credit score is not nearly as dire as expected. Over time, you can vastly improve your cedit score after a bankruptcy, possibly making you eligible for more loans in the future.
One reason your score would not be seriously affected is that, if you are in such dire circumstances to even consider filing for bankruptcy, then chances are you don’t have a stellar score to begin with.
After filing, some consumers may even see a slight bump up in their credit scores. And this is due to credit report being largely wiped clean after a bankruptcy. Your high balances are removed as well as any late payments or records of unpaid debts. All the accounts included in your bankruptcy will be noted as “Included in Chapter 7 Bankruptcy” or “Included in Chapter 13 Wage Earner Plan,” depending on which type of bankruptcy you filed.
Of course, you aren’t likely to see a big boost, however, if you’ve just been getting by or not paying bills at all, your credit isn’t likely to fall much further.
But a bankruptcy could help improve your score over the long term. The reason? When calculating scores, the FICO formula used to calculate credit scores are set up to grade the consumer’s credit standing as compared with that of other consumers in a similar financial situation. To do that, divides consumers into 10 groups, using what it calls “score cards.” It then ranks the consumers in each group based on the others in the group. One of these score cards is bankruptcy filers. (For competitive reasons, Fair Isaac doesn’t release what constitutes all 10 groups.)
In other words, when you file bankruptcy your score is determined based on how you do compared with other bankruptcy filers,
As a result, credit scores can run the gamut among bankruptcy filers. “In that population, you’ll find some consumers who have very good FICO scores, some who have very bad FICO scores, and in between,” Watts says. (Fair Isaac doesn’t have statistics on the average FICO score for bankruptcy filers.) Granted, you won’t be able to bring your score up to the perfect 850 as long as your bankruptcy stays in your report, but with good credit management after filing, a score in the 700s isn’t impossible.
Then again, your credit score alone shouldn’t affect whether or not you decide to file bankruptcy. Most experts would still say that if you can dig your way out of debt without declaring bankruptcy, that’s a better way to go, since, among other things, you may be forced to sell certain assets — in some states even your home or car — to meet the bankruptcy filing requirements. (This can be the case with Chapter 7 bankruptcy, but not Chapter 13.) Another issue: Given the tougher new bankruptcy rules, you may not even be able to declare bankruptcy.
That said, if your debt payments are crushing you, bankruptcy will give you a much-needed fresh start. And with a few clever credit repair strategies, your score could be back in the 700s within two or three years.