Financial Gurus are frequently discussing credit scores, all bringing their own unique perspectives to the conversation. Everyone knows that filing bankruptcy will hurt their credit score, but how badly does it really hurt your credit? If you have a very high credit score, then filing a bankruptcy could drop your score by around 200 points. However, if you have a low credit score it could drop your score by 100 to 150 points. The lower your score to begin with, the less the bankruptcy will affect it. So, if you already have the lowest possible credit score, around 300, then a bankruptcy may not drop your score at all.
There are two different types of consumer bankruptcy, Chapter 7, and Chapter 13 (Chapter 11 is for primarily corporations and Chapter 12 is for primarily commercial farmers and fishermen). Each will have a different impact on your credit report. In a no-asset Chapter 7 bankruptcy you do not repay your debts, they are simply discharged. In a Chapter 13 bankruptcy the court places the debtor into a three-to-five-year repayment plan. So, in a Chapter 13 bankruptcy the creditors do receive some money. Clients ask me if filing a Chapter 13 bankruptcy and repaying some of their debts will improve their credit faster than a Chapter 7 bankruptcy. I do not believe that a Chapter 13 bankruptcy will help a debtor improve their overall credit worthiness more quickly than a Chapter 7.
Typically, the average Chapter 7 bankruptcy is filed and closed in a matter of a few months. Which means it starts aging on your credit report shortly after you file it. The Chapter 13 bankruptcy is an open, active case on your credit report for up to five years. In many cases you can buy a car on credit weeks or months after filing a Chapter 7 bankruptcy. Many people can purchase a home with a mortgage in as few as three to four years after filing a Chapter 7 bankruptcy. But, buying a car or house while in an open, active Chapter 13 bankruptcy is not any easy task in most jurisdictions.
Obtaining credit after filing a bankruptcy is not impossible. The vast majority of my clients can find housing to rent after bankruptcy. They can purchase a car on credit shortly after filing bankruptcy, and they are able to buy a house a few years after filing bankruptcy. So, what’s the downside of bankruptcy? With a bankruptcy on your credit report, at least for a several years, you will be required to pay much higher interest rates on money that you borrow. A person with good credit can buy a car with a low interest rate, saving them thousands of dollars across the life of the loan.
A person with a bankruptcy on their credit report may be required to pay a very high interest rate, upwards of 18% or more. For example, a person with good credit, maybe a 790-credit score, could be offered a 2% interest rate. His car payment ends up being $500.00 per month with $30.00 a month going towards interest. The person with bad credit goes to the same dealership, the same day, and buys the same exact car. But the person with bad credit pays $740.00 per month for the same car, with well over $200.00 per month going to interest on the loan.
The person with good credit saves thousands of dollars in interest payments over the life of the loan. In this example, the person with bad credit is paying $240.00 per month more than the person with good credit for the same car. If it’s a 60-month loan, then the person with bad credit pays a whopping $14,400.00 more for the same car than the person that has good credit. That’s a steep price to pay just for having bad credit!
After bankruptcy your credit score could be much lower. You should avoid buying large items, like cars, on credit until you have significantly improved your credit score. So, how can you improve your credit score after bankruptcy if you are avoiding large purchases? After bankruptcy, if your goal is to improve your credit score, you should obtain three to five credit lines that report to your credit bureau. These credit lines should be small, maybe even secured credit cards. If you really need a car, then buy the cheapest car on credit that you can find.
Why buy a cheap car on credit? Because the interest rate will still be high but the amount of interest you actually pay will be much less because it’s based on a smaller principal debt. If you have to pay a high interest rate, you are far better paying it on a $5,000.00 loan than a $25,000.00 loan. If you make all the payments on time for the cheap car, then your credit score will improve, perhaps allowing you to buy the more expensive car at a much lower rate in the future.
Realistically, if you are seriously considering bankruptcy then you probably already have several delinquent accounts reporting to the credit bureau. While the bankruptcy may lower your credit score, you may be more creditworthy after bankruptcy.
The reason for this is because before you filed bankruptcy you had numerous creditors reporting to the credit bureau thousands of dollars in outstanding debt.
After you file bankruptcy, while the historical fact that you owed the debt remains on your report, it is no longer being reported as an active debt that you still owe.
Before you filed bankruptcy, when you had all these creditors chasing you, you were a huge credit risk to potential lenders. A potential lender would deny you credit for fear that an old creditor would pop up and garnish your wages, making it impossible for you to pay him. After bankruptcy that same lender is more likely to loan you money because he knows that you don’t owe anyone else money, so you can afford to pay him back.
The attorneys at John W. Lee, PC have helped thousands of people file bankruptcy in Hampton Roads and surrounding communities. We offer a free consultation to help you decide if bankruptcy is right for you. At that consultation we will review your financial situation, explain how bankruptcy will affect you going forward, and help you decide which course of action best suits your needs.