Bankruptcy and Your Credit ScoreOut of all the things my clients have questions about, the overriding topic of discussion is almost always the enigmatic FICO credit score and how bankruptcy affects it.  I figure now is as good a time as any to sit down and write out a manifesto of sorts regarding how bankruptcy affects your credit.

1. How Long Is Bankruptcy Listed On My Credit Report?

This is the most common question by far, but also the least understood.  Here’s the quick and dirty answer:

1. Chapter 7 and 11  – 10 Years from discharge

2. Chapter 13 – 7 years from discharge

So once you receive your Chapter 7 discharge that wipes out all your debts, a bankruptcy will be listed on your credit report for 10 years. This does not, however, mean that it will be materially affected for 10 years. Yes, it will technically be affected for 10 years, but I have had clients come back with 740 credit scores two years after receiving their Chapter 7 discharge.

Chapter 13 debtors will begin to see an improvement shortly after completing their plan payments, whether it be a 3 year or a 5 year plan.

2. How Much Will My Credit Score Drop After Filing?

This depends on how good your credit score was prior to filing bankruptcy. The better your credit before filing, the bigger the drop in points after filing.  The thing to remember here is that if your credit was good before filing, it would have been hit by whatever bill payment you were going to miss prior to filing bankruptcy anyways, so it’s largely irrelevant. In general, expect anywhere from a 50 to 150 point drop in your credit score.

3. Is There Any Difference Between a Chapter 13 and a Chapter 7 When It Comes To Your Credit?

No, there is no difference, though certain creditors, such as future landlords, may view a Chapter 13 debtor in a more favorable light since you have to have an income to file Chapter 13.

4. When Can I Buy a House and Car?

If you can pay cash, whenever you want, but the real question here is “When will I qualify for a car loan or mortgage?”. You can buy a car straight after a Chapter 7 or even during a Chapter 13. But the only lenders who will deal with you are the “buy-here-pay-here” places that charge exorbitant interest rates. Provided you have paid all your bills on time after receiving your discharge, you should be able to qualify for a decent car loan within one year.

The Federal Housing Administration (FHA) and Department of Veteran Affairs (VA) have very specific guidelines for qualifying borrowers who have asked for relief under the bankruptcy code. You generally have to wait two years after a Chapter 7 and one year after a Chapter 13 to qualify for a mortgage. For conventional mortgages, you will have to wait 2 to 4 years, depending on the bank.  For lenders that sell their debt to Fannie Mae, you will have to wait 2 years after a Chapter 13 is completed and 4 years after a Chapter 7.

When a bank is assessing how risky a borrower is, other things taken into consideration will include your income, size of your down payment, and debt-to-income ratio at the time of the application.

5. How Can I Improve My Credit Score After Bankruptcy?

Never be late on a payment again. That’s the best tip I can give you to improve your credit score after bankruptcy. Your credit score is based, first and foremost, on your payment history, and continuing to make late payments is the number one reason why people fail to improve their credit after bankruptcy.

A little research on the web will uncover some rather cookie cutter advice like opening up a secured credit card and applying for a gas card with a small limit and paying it off in full at the end of every month.  This is not bad advice at all, but the most important thing is to never be late on your bills, including any new credit cards you may qualify for.

During this rebuilding phase, try not to max out your credit limit each month, as that could make the process a little slower. For example, if you have a $200.00 limit on your gas card, make an effort to keep the monthly charges less than $100.00.  And remember to always pay the balance off at the end of the month.

Another important step is to request a copy of your credit report from Experian, Transunion, and Equifax and check for any errors, including whether a bankrupt debt is listed as merely “charged-off” or discharged. Everyone is entitled to a free copy of their credit report once per year, and is the best place to get your report from all three agencies.

If you have completed a Chapter 7, each debt should be listed as discharged with a balance on $0. If you are in the middle of a Chapter 13, a debt may still be listed as “charged-off”, but at the end of the payment plan, it should be updated to “discharged.” Most of the time, a debt will say “bankruptcy plan” or something similar while you are still making payments through a Chapter 13 plan.

Lastly, stay away from title pawns and payday loans.  This is how many people are forced into bankruptcy in the first place.