Will Bankruptcy Ruin My Credit Score Forever?

Filing for bankruptcy can be a difficult decision. Many people worry that it will wreck their credit score and make it impossible to get loans or credit cards in the future. But does bankruptcy really ruin your credit forever? The short answer is no, bankruptcy does not permanently destroy your credit. However, it will negatively impact your credit score in the short-term. With time and effort, you can rebuild and improve your credit over the long run.

How Bankruptcy Impacts Your Credit Score

When you file for Chapter 7 or Chapter 13 bankruptcy, it immediately shows up on your credit report. This causes your credit score to take a big hit. On average, filing for bankruptcy can cause your credit score to drop by 130-240 points depending on your starting score. The higher your pre-bankruptcy score, the more points you will lose. For example:

• A person with a 680 credit score may see it drop by 130-150 points after filing for bankruptcy.
• Someone with a 780 score could see their score plummet by 200-240 points post-bankruptcy.

This happens because bankruptcy directly impacts several factors that make up your credit score:

• Payment history – When you file for bankruptcy, you stop making payments on your debts. This will show up as late and missed payments on your credit report.
• Amounts owed – While bankruptcy wipes out many of your debts, it does not make them disappear from your credit report right away. They will still show up as unpaid balances.
• Length of credit history – The accounts included in your bankruptcy will be closed, shortening your credit history.
• New credit – After bankruptcy, you will likely have difficulty getting approved for new credit accounts.

As a result, the bankruptcy causes your creditworthiness to take a temporary nosedive. You go from being a moderate or low credit risk to a high-risk borrower in the eyes of lenders.

How Long Bankruptcy Hurts Your Credit

The negative impact of bankruptcy on your credit score does not last forever. Here is how long bankruptcy stays on your credit report:

• Chapter 7 bankruptcies remain for 10 years from the filing date.
• Chapter 13 bankruptcies fall off your credit report after 7 years.

For the entire time the bankruptcy is on your report, it will continue to drag down your credit score. However, the effect lessens over time. A 3-year-old bankruptcy hurts your score much less than one that just appeared last month. Once the 10 or 7 years runs out, the bankruptcy disappears from your credit report completely.

Rebuilding Your Credit after Bankruptcy

The good news is that you can start rebuilding your credit long before the bankruptcy drops off your report. Here are some tips to improve your credit score after bankruptcy:

• Get a secured credit card – Secured cards require a refundable security deposit and are easier to get after bankruptcy. Use the card responsibly to begin rebuilding credit.
• Become an authorized user – Ask a friend or family member with good credit to add you as a user on their credit card. It will help improve your score.
• Limit new credit applications – Apply for new credit sparingly, as too many applications can hurt your score.
• Pay all bills on time – On-time payments help boost your score, so pay rent, utilities, and other bills by the due date.
• Monitor your credit – Review your credit reports regularly and dispute any errors with the credit bureaus.
• Wait it out – As time passes, the negative impact of the bankruptcy will diminish.

If you follow these tips and practice good credit habits, your credit score can quickly rebound from the bankruptcy. Many people see their scores improve significantly within 2 years of filing.

Does Bankruptcy Beat Defaulting on Debt?

For some people, the question is not whether bankruptcy will hurt their credit, but whether it will hurt more than defaulting on their debts. If you cannot realistically pay back what you owe, then default is your only other option. In that case, filing for bankruptcy may actually be better for your credit in the long run.

Here’s why:

• Defaulting leaves all accounts open and accruing interest and fees. Bankruptcy wipes out most debts completely.
• Defaulted accounts can be sent to collections for years. Bankruptcy stops collections calls.
• After a few years, a discharged bankruptcy looks better than multiple defaulted accounts on your credit history.

So if you have no way to avoid default, the credit score damage may be less if you file for bankruptcy instead. By discharging debts in bankruptcy, you can start fresh and begin rebuilding your credit right away.

Alternatives to Bankruptcy

While bankruptcy is one way to deal with unmanageable debt, it should not be your first option. Some alternatives to explore first include:

• Debt management plan – A DMP provided by a credit counseling agency helps you repay debt through one monthly payment. It can lower interest rates but won’t discharge debt.
• Debt consolidation loan – Combines multiple debts into one new loan with lower monthly payments. This also keeps accounts open.
• Credit counseling – Nonprofit credit counseling provides advice on managing money and dealing with creditors. They can help you budget and negotiate with creditors.
• Debt settlement – The creditor or debt collector agrees to let you pay a lump sum that is less than the full amount owed. This closes accounts.

While these options may damage your credit score less than bankruptcy, they also have more requirements and risks. Speak to a credit counselor or financial advisor to understand all your debt relief options.

The Bottom Line

Bankruptcy will seriously damage your credit score temporarily. However, it will not ruin your credit forever. If you manage your credit wisely after bankruptcy, your score can recover in just a few years. In some cases, choosing bankruptcy over defaulting on debt may actually help you rebuild credit sooner. So don’t panic if you need to file for bankruptcy. With time and effort, you can bounce back and regain good credit.