Bankruptcy and Its Effect on Your Credit Score

The U.S. economy has experienced one of the most turbulent times in its history over the past few years. A weak housing market and high unemployment rates have left many people uncertain about their future while struggling to get out from under debt.

As a result of these difficult economic times, many people have been forced to consider bankruptcy. According to The Wall Street Journal, 1.41 million people filed for bankruptcy in 2009, up 32 percent from 2008. While bankruptcy has been a helpful and necessary process for many people, some are hesitant to take that step out of fear or a misunderstanding of how bankruptcy works. One common question for people considering Chapter 7 or Chapter 13 is: How will bankruptcy affect my credit score?

How Your Credit Score is Calculated

Nearly 50 percent of consumers do not understand the purpose of their credit score according to a survey by Consumer Federation of America and Fair Isaac Corporation. Lenders use credit scores as part of their reasoning to extend or deny credit to consumers; it can also affect the interest rates and amount of loans people receive. In other words, a poor credit score can make a loan more costly.

To measure this risk, Fair Isaac developed the FICO score, the most commonly used formula to determine a person's credit score. Scores range from a low of 300 to a high of 850, with the average score being 723 according to Bankrate.com.

A Business Week report notes that Fair Isaac uses 22 pieces of data from the three major reporting agencies - Experian, TransUnion and Equifax - to calculate a credit score. Though income is not a factor, five other data points make up the bulk of the FICO score:

  • Payment history (35% of the rating)
  • Length of credit history (15%)
  • New credit (10%)
  • Types of credit used (10%)
  • Debt (30%)

Bankruptcy and Foreclosure

As credit scores are a measure of credit risk, the scores of people who have filed for bankruptcy can fall, but late payments on mortgages can have an impact on scores as well.

According to a recent CNN report, a mortgage payment that is 30 days past due can drop a score anywhere from 40 to 110 points. Being 90 days late can cause the score to fall 70 to 135 points. But foreclosures and bankruptcy can have the most significant impact on scores with a foreclosure causing an 85-160 point drop and bankruptcy taking a score down 130-240 points.

Credit Report Designation and Improving Your Score

According to Experian, accounts discharged in a bankruptcy will remain on your credit report for a maximum of seven years. The bankruptcy itself, however, can remain on the credit report longer depending on which chapter you file. If filing under Chapter 13, the bankruptcy can remain noted on your credit report for seven years. If a Chapter 7, 11 or 12, the designation can remain for up to 10 years.

Despite the immediate impact the bankruptcy can have on your score, it is possible to take steps to improve your long term credit outlook. Business Week notes several steps that consumers can take to improve their credit score:

  • Pay bills on time - This is the most weighted factor in FICO scores. If you are always late, your score can drop as much as 100 points.
  • Keep credit balances low - FICO scores calculate your score based partly on your available credit to your outstanding balances.
  • Judiciously close credit accounts - Creditors like to see consumers with established and lengthy credit histories.
  • Use discretion when applying for credit - When you apply for credit, lenders request a copy of your report. This request is noted on your credit report and can reduce your score.

Perhaps the most important thing to do when rebuilding your score is to be patient. It can take some time to rebuild credit, but by living within a budget and paying your bills on time your score will gradually improve.

Working With an Attorney

Bankruptcy is a complex process, but can give people the fresh start they need. If you are considering bankruptcy or concerned about how it will affect your credit and your future, discuss your situation with an experienced bankruptcy lawyers near me.