Will Bankruptcy Destroy My Credit?

It is impossible to generalize about the effect of Bankruptcy on credit.

A Chapter 7 bankruptcy can be reported by a credit reporting agency for 10 years after filing.  A Chapter 13 can be reported for 7 years after filing.  Although a creditor is free to deny credit because a debtor filed bankruptcy, this does NOT mean debtors will not have credit for 10 years.  The report of your discharge may IMPROVE your credit since creditors understand that much of your debt load has been removed.  Further, Bankruptcy can prevent new judgments for claims which are discharged and the debtor can apply to remove court records of judgments based on discharged claims.

In many cases the debtor’s credit is so bad that it cannot get any worse.  Sometimes a debtor has a great deal of debt that could never be repaid — certainly not in the foreseeable future, but earns a fairly good salary.  In other cases liens or debts which could be discharged in bankruptcy impair a debtor’s ability to earn a living or to secure credit.  In such cases bankruptcy may improve a credit rating.

A debtor’s credit rating is often at its worst just before a bankruptcy is filed.  At this time credit will be difficult because the creditor believes the debtor will soon file bankruptcy, discharging most unsecured debt.  AFTER a bankruptcy is filed, much or even all debt may be discharged. With much less debt the debtor is better able to repay new loans or other obligations.  In some cases the debtor will end up with less property to be maintained.

It is more difficult for a Chapter 13 debtor to quickly restore credit, but in the longer term the filing can be beneficial.  The ongoing obligation to repay creditors under the Plan will last for 36 to 60 months.  The Plan will often give the Debtor a respite – time in which to make up problem secured debts, taxes or other debts.  To a creditor, the monthly drain on the debtor’s resources will make it appear more difficult to repay a new loan. But a creditor may view the Chapter 13 as a good faith attempt by the debtor to pay what was possible to creditors.  Successful completion of a Plan also shows financial responsibility and a stable history of debt payments.

The other way to frame this question is: How quickly can I restore my credit?  This depends on how bad your credit was before you filed bankruptcy, what debts will remain after you file bankruptcy, what property you will retain, your income and other resources (such as a potential co-signer, or provable impending windfall).

How good your credit will be also depends on what you will use your credit for.  Many debtors are surprised to find creditors offer them new car loans shortly after filing bankruptcy.  Such credit is often available, although the interest rate will sometimes be higher.  If you intend to purchase a home, you should anticipate a two year wait before you qualify for FHA financing.  Conventional financing, which will require a higher down payment will be easier to arrange.  Of course, it will be possible to secure financing earlier by finding a willing seller, perhaps one willing to offer a Contract for Deed.  A helpful creditworthy friend of relative could be a co-signer/guarantor.

You may be better served by asking why you need credit or devising a plan to reduce your need for credit.  Many living on a fixed income can sustain their standard of living better by waiting somewhat longer before replacing a used car and being selective in improvements for their home.

You should plan ahead.  If a Chapter 7 is in your near future and your credit is decent and your old car must be replaced, you may want to purchase before filing.  Once you have filed Bankruptcy, the payments on the new car may help you build credit.  In other cases, refinancing a home mortgage or car loan may affect your scheduled Chapter 13 Plan payments or make it easier to pass your Means Test. [See What is the Means Test.]

By not filing Bankruptcy, your credit report may show negative information for 7 years from the time you become current. By filing, negative reporting stops immediately, except of course for the report of the bankruptcy. This allows you to begin re‑establishing credit faster by keeping house, auto or other payments current.