How Bankruptcy Impacts Your Credit Score

Bankruptcy is a legal procedure that helps individuals and businesses who cannot pay their debts. It facilitates a second chance for those unable to meet their financial obligations, providing relief and a fresh start. The process typically starts with a petition filed by the debtor, which is more common, or on behalf of creditors, which is less common. Going bankrupt is serious and can affect your finances, so it shouldn't be treated casually. These can include a drop in your credit score, loss of properties/assets, insurance premiums, and financial opportunities. Moreover, the impact can even be contagious to your personal life.

If you are considering bankruptcy for financial recovery, continue to scroll down. Hereunder, Urban Money presents a detailed overview of how bankruptcy impacts your credit score and other aspects of your financial life. Let’s get started!

Impact of Bankruptcy on Your Credit Score

Here are the key aspects of how bankruptcy impacts on your credit score and beyond:

1. Significant Drop in Credit Score

Your credit score takes a massive hit when you file for bankruptcy. The exact impact can vary, but it’s not uncommon to see a drop of 200 points or more, especially if you had a good score before filing. This decline reflects the high level of risk you now pose to lenders, indicating severe past difficulties in meeting your financial obligations. Such a significant decline resets your position in the financial community, making it difficult to restore trust among investors.

Moreover, this drop in score can make basic financial activities challenging, such as qualifying for a phone plan, getting utility services without deposits, or even approving rental applications. Over time, as the bankruptcy ages, its impact may lessen, but initially, it is a considerable setback that affects various aspects of your financial life.

2. Bankruptcy Duration on Credit Report

A bankruptcy impacts your credit score and remains visible for the long term. Chapter 13 bankruptcy remains on your report for seven years, while Chapter 7 stays for ten years. This prolonged presence acts as a constant reminder of your financial crisis. Although the effect on your score diminishes over time, the record can discourage lenders, landlords, and potential employers from entering financial arrangements with you. Additionally, the stigma of a bankruptcy filing can affect your ability to obtain unsecured credit, secure housing without high-security deposits, or land jobs that require a clean financial record. Employers in the financial sector or positions involving financial responsibilities might consider a past bankruptcy a risk, potentially impeding your career progress.

3. Limited Access to New Credit

Securing new credit after bankruptcy is an uphill battle. You may typically face outright rejections from most mainstream lenders. Thus, you might have to turn to subprime lenders who cater to high-risk borrowers, but these options often come with steep interest rates and unfavourable terms. You may also be required to provide a security deposit or find a co-signer for loans and credit cards. This difficulty in obtaining credit hampers your ability to rebuild your credit score quickly because having and using credit wisely is key to credit recovery. Ultimately, you might find yourself in a tricky situation where you need credit to improve your credit score but can’t access it affordably due to bankruptcy.

4. Higher Interest Rates and Fees

Any new credit lines you can open will incur significantly higher costs. Lenders offset the risk of lending to someone with a bankruptcy history by charging higher interest rates and sometimes additional fees. This means that credit cards, car loans, and mortgages you qualify for will not only be more costly every month, but the total amount repaid over the life of the loan will be much higher than someone with a healthier credit score would pay. These high costs can make financial recovery slower and more challenging, as more of your income will go towards servicing debt.

5. Impact on Professional Opportunities

Bankruptcy can severely affect your professional opportunities. Particularly in industries that scrutinise financial histories, such as finance, law enforcement, or positions that require a security clearance. Such industries may see bankruptcy as a sign of poor financial management, potentially stalling career advancement or making it difficult to change fields. Consequently, you might end up in jobs in sectors that don’t consider credit history, which could limit your job satisfaction and growth. For entrepreneurs, bankruptcy makes it harder to secure loans, attract investors, or gain trust from suppliers and partners. This creates significant obstacles in maintaining or expanding business operations.

5. Strain on Personal Relationships

The stress of dealing with bankruptcy extends beyond finances; it can deeply affect personal relationships. The stigma and shame associated with declaring bankruptcy can lead to social embarrassment and isolation. If your bankruptcy affects shared finances, such as those with a spouse or business partner, it can lead to friction or even breakdowns in relationships. The pressure to recover financially can also strain relationships, as it might necessitate tightening budgets, sacrificing personal desires, or increasing work hours to meet financial obligations.

6. Long Road to Credit Recovery

Rebuilding your credit after bankruptcy is a painstaking process. It ideally requires diligent financial management and patience. You must adopt stringent budgeting practices and regularly monitor your credit report for inaccuracies. Gradually take on new credit in forms that allow you to demonstrate reliability without incurring high costs. Over time, responsible credit use—such as maintaining low credit balances and making timely payments—will help to mitigate the negative effects of bankruptcy. However, recovering from bankruptcy is truly a marathon, not a sprint, and requires sustained effort to improve your credit score and regain financial stability.

How Long Will Bankruptcy Remain on My Credit Record?

The time that bankruptcy impacts your credit report depends on the type you file. These typically can be either Chapter 7 bankruptcy or Chapter 13 bankruptcy, as follows:

Chapter 7 Bankruptcy

A Chapter 7 bankruptcy is known for its liquidation approach, where you sell off your assets to pay your debts. This remains on your credit reports for up to 10 years. It’s managed by a trustee who handles the sale and gives the money to your creditors. It is primarily designed for individuals who need help to settle unsecured debts, such as credit card bills, overdrafts, and personal loans.

Moreover, Chapter 7 provides a relatively quick way to be free from these debts, typically concluding within three to six months. While it can offer a fresh start by wiping out most debts, it also leaves a significant mark on your credit report for ten years. However, on-time payments and responsible credit use during these years can help mitigate the negative effects as the record ages.

Chapter 13 Bankruptcy

This type of bankruptcy stays on your credit report for seven years. Commonly referred to as reorganisation bankruptcy, it involves a repayment plan instead of selling your assets to pay debts. For example, debtors may implement a plan to make payments to their creditors over three to five years. Credit reporting agencies view this more favourably because it shows an effort to repay debts rather than just eliminating them. This proactive approach justifies the shorter duration on the credit record compared to Chapter 7 bankruptcy. As the record gets older and you continue making payments on time, the impact of bankruptcy on your credit score diminishes. Nevertheless, it is important to note that fully restoring your credit requires careful financial management over the years.

Can Bankruptcy Be Removed From Credit Score?

Bankruptcy cannot be removed from your credit report based solely on personal desire. It serves as an official record of your financial history and is mandated to remain visible on your credit report for a predetermined duration.

As mentioned above, Chapter 7 bankruptcy is recorded for ten years, whereas Chapter 13 bankruptcy appears for seven years. Nonetheless, the impact of bankruptcy on your credit score lessens over time, particularly if you take deliberate actions to rebuild your credit.

Enhancing your credit standing involves diligent, timely bill payments, reducing existing debts, and vigilant use of new credit lines. Although you cannot erase bankruptcy from your credit report, these proactive measures can help mitigate its adverse effects and gradually improve your credit score. In essence, stay patient and disciplined in your financial habits. These key qualities are vital to recover as strongly as possible after such a significant setback.