While how much will bankruptcy cost is the number one question prospective clients ask me, the number two question is what will bankruptcy do to my credit. It is hard to answer this question with any specifics because how credit scores are determined is somewhat of a guarded secret by the three credit reporting agencies. Each agency has its own formula and that is why you will often end up with three different credit scores from each agency. The agencies I am talking about are Experian, Equifax, and Transunion.
There are some general rules regarding these services. They are very interested in the current status of payments, how much available credit has been used, the amount of outstanding consumer accounts, the types of accounts, the frequency that accounts are opened, the balance you carry, what your monthly payment amount is, if you have any judgments, and if you have ever been foreclosed on. The credit reporting bureaus use this information to generate your credit score. How much weight is given to each item is more difficult to estimate.
As it relates to bankruptcy, the fact that you have filed may be on your credit report for up to 10 years. The actual impact on your credit report and your credit score will most likely not last that long. As a general guide, the most impact on the report and your score will take place in the 2 years following your discharge. During that two year period you should take all necessary steps to build your credit back up.
One thing to keep in mind about bankruptcy is that it is like hitting the reset button on your finances. This includes your credit history. It is a fresh start but there is a cost to that fresh start above the fees you will pay. That cost is starting over on your credit history.
As it relates to the credit score, for most people filing bankruptcy there will be little to no impact on the score itself from filing. Most people filing bankruptcy are already at the mid-500s because of significant late payments on their accounts or other things like judgments or foreclosure. Bankruptcy, in general, will not take your score any lower than the mid-500s and, in most cases, your score will improve itself by about 100 points over the 12 month period after your discharge. The score will also increase as you demonstrate good credit use through secured credit cards and/or car loans.
The impact of bankruptcy will most likely come in the interest rates you will pay for loans. You will not be able to get 0% auto loan financing for a while after your bankruptcy. Interest rates on car loans will most likely be in the 9%-15% range for at least 12 months after your discharge. Credit card rates will be significantly higher, in many cases above 28%. Really, the impact of bankruptcy is on the interest rates you will be able to get on any loan you are trying to take out.
In the end, how bankruptcy will impact your credit score is going to depend on your circumstances and your improved use of credit after bankruptcy. In deciding whether to file for bankruptcy protection, the impact on your credit score should not be a high consideration. The focus should be on whether bankruptcy will improve your financial situation. For many people the answer is yes. Next week I will discuss how bankruptcy can save your home from foreclosure.