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Bankruptcy may help relieve your debt obligations, but it will impact your credit for years.
Bankruptcy is a special legal proceeding you can use to reorganize or get rid of your debt, depending on your financial situation. Bankruptcy can be helpful if you’re overwhelmed with financial commitments, but it could also negatively affect your credit. A bankruptcy will generally stay on your reports for up to 10 years from the date you file.
“I refer to bankruptcy as kind of Armageddon on someone’s [credit],” says Freddie Huynh, vice president of credit risk at Freedom Financial Asset Management.
The good news is your credit can gradually heal if you take the right steps. Here’s what can happen to your credit reports when you file for bankruptcy.
How bankruptcy appears on your credit reports
Bankruptcy is a type of public record that can be listed on your credit reports. As long as it’s listed on your reports, the bankruptcy may negatively impact your credit.
What are the different types of bankruptcy?
There are several different types of bankruptcy. If you're thinking about filing, consult a qualified attorney or credit counselor who can help advise you. Here are the two main types of bankruptcy for individuals, also known as personal bankruptcy:
Chapter 7 bankruptcy
In Chapter 7 bankruptcy (also called “straight bankruptcy”), you can generally keep your exempt property, which may include your car, clothes and furniture. However, the nonexempt property may be sold by a neutral third party, referred to as the trustee, who’s appointed to your case by the court. In return, some or all of your debts may be forgiven. This type of bankruptcy may take up to six months to complete. To qualify for a Chapter 7 bankruptcy, your income can’t exceed a certain amount, which varies by state.
Chapter 13 bankruptcy
In some cases, Chapter 13 bankruptcy can allow you to keep your property. Instead of a trustee selling your property to pay off debt, you pay back some or all of your debt over a period of three to five years. You must have a regular income to qualify for this type of bankruptcy, but there are no income limitations on who can file.
According to the Fair Credit Reporting Act, a Chapter 7 bankruptcy may stay on your reports for 10 years from the date you file. A discharged Chapter 13 bankruptcy typically stays on your reports for seven years from the date you file, but it could remain for up to 10 years if you don’t meet certain conditions. Both types have the same impact on your credit scores. However, it’s possible that a future lender could view one type more favorably than the other.
This type of public record may lower your scores significantly. If your credit was healthy before the bankruptcy, it may be hit harder than someone with poor credit. Ultimately, how a bankruptcy affects credit can vary, partially because of the different factors that make up each person’s credit.
How accounts appear on your credit reports
Before filing for bankruptcy, you probably had bills you struggled to keep up with — credit cards, medical debt and more.
When you include those accounts in a bankruptcy filing, they’ll still be reported on your credit reports. Accounts discharged in bankruptcy can be reported as “discharged” or “included in bankruptcy” with a zero balance. Even though you owe $0 for them, they’ll still appear on your reports. If you apply for credit, lenders may see this note when they check your reports, and they may deny your application.
But here’s that good news we promised: Accounts included in a bankruptcy filing won’t be reported as “unpaid” or “past due” anymore, and you may feel relief without those financial burdens.
Your credit scores will eventually start rebounding with those positive effects, Huynh says. That’s assuming, of course, you use credit responsibly from here on out.
Credit recovery post-bankruptcy
After filing bankruptcy, you can work to build your credit again — but it won’t be instantaneous.
“It’s a marathon, not a sprint,” says Huynh.
Start by making a list of the debts included in your bankruptcy, and check them on your credit reports. After they’re discharged, it may take about two months for the accounts to be updated on your reports. They should be labeled “included in bankruptcy”, “discharged” or similar language.
Check your reports every few months for errors. Make sure to check that the negative marks are removed in a timely fashion.
In the meantime, consider building credit with a secured credit card. Only take out lines of credit you can afford, and pay back debt as agreed. After several years’ worth of responsible credit behavior, your credit scores can improve.
“If someone walks the straight and narrow after bankruptcy,” Huynh says, “it would be possible their scores would be higher now than prior to the bankruptcy.”Learn more: How does a secured credit card work?
For many, bankruptcy is a last resort. If you’re considering filing, know the financial and credit implications.
Your credit will show a public record of bankruptcy for up to 10 years, and discharged accounts will get a negative mark. You can lessen the effects on your credit by responsibly using credit going forward and making sure your credit reports accurately reflect your situation.