A common misconception about bankruptcy is that it ruins the debtor’s credit score forever and that no one will ever lend to the debtor ever again. This false assumption is further perpetuated by many “debt consolidation agencies” because they want to dissuade debtors from filing bankruptcy and force them into debt repayment plans, which are not the best option for all people who owe significant debts.

The impact of a bankruptcy filing on the credit score of an individual person is highly-dependent on the chapter of bankruptcy the individual is filing and how the individual acts to repair his or her credit after the bankruptcy is filed.

The first impact on an individual person’s credit score as a result of a bankruptcy filing is the chapter of bankruptcy being filed. If an individual is filing a chapter 7 bankruptcy, he or she will generally notice a greater decline in his or her credit score upon filing than if the same individual were to file chapter 13 bankruptcy. Many individuals will notice a 100-200 point drop in FICO score when a chapter 7 bankruptcy is filed and a 75-150 point drop in FICO score when a chapter 13 bankruptcy is filed. This will vary based on the pre-bankruptcy credit score of the borrower and other myriad factors which are not within the scope of this article. Generally, the higher the credit score pre-bankruptcy, the more points are deducted from an individual’s FICO score when he or she files. Individuals with bad credit experience less of a drop because in many cases these people already have a low credit score due to missed payments, high borrowings relative to total debt, and other reasons. The credit reporting agencies often view chapter 7 bankruptcy as “worse” than chapter 13 bankruptcy because creditors often receive higher distributions statistically from chapter 13 cases than chapter 7 cases. However, in many cases, chapter 7 bankruptcy will often allow individuals to rebuild credit faster than the same individual can in chapter 13 bankruptcy, because chapter 13 bankruptcies usually last much longer (3-5 years) than chapter 7 bankruptcies (3-6 months). Additionally, chapter 13 debtors are prohibited from incurring new debt without approval from the bankruptcy court, which can make it more difficult for chapter 13 debtors to establish new credit and rebuild a credit score. Generally, debtors filing chapter 7 cases can begin rebuilding credit with secured credit cards, auto loans (at higher interest rates), or other loans very soon after receiving the bankruptcy discharge, which usually occurs within 3-6 months of filing for bankruptcy. Some creditors will even lend money to a chapter 7 debtor while in bankruptcy, but generally it is recommended to avoid incurring new debt during the chapter 7 case unless it is an emergency (car breaks down, medical emergency, etc.). In contrast, chapter 13 debtors must wait to accumulate new lines of credit until after bankruptcy unless such debt is incurred with bankruptcy court approval. This can mean that chapter 13 debtors will not actually be able to obtain new credit for 3-5 years after filing bankruptcy, unless a sufficient reason is given for the court to allow the new debt, such as an emergency need to finance a car or other item needed for the debtor’s business or profession. Accordingly, even though chapter 7 bankruptcy often results in a larger credit decline initially than chapter 13 bankruptcy, many debtors filing in chapter 7 can rebuild their credit faster than comparable debtors filing in chapter 13 bankruptcy.

The second impact on an individual person’s credit score as a result of a bankruptcy filing is the action that such individual takes post-bankruptcy to rebuild his or her credit. This credit rebuilding phase usually can begin within 3-6 months after filing for chapter 7 debtors, and 3-5 years after filing for chapter 13 debtors. During this phase, Nova Law Group recommends that a client slowly apply (not more than one application for credit every six months) for new credit lines until they reach a minimum of three. These credit lines can be credit cards, bank lines of credit, auto loans, installment loans, or any other type of loan from a creditor that reports to the credit reporting agencies. However, a client should only obtain credit if it is useful to the client. For example, a client should never get an auto loan if the client doesn’t need a car. With regard to credit cards, even if a client never wants another credit card, Nova Law Group recommends that a client simply obtain enough credit cards to reach the minimum of three credit lines, and then the client can stop accumulating credit for credit rebuilding purposes. As part of rebuilding credit, a client should utilize the credit line or credit offered each month, but can utilize a very small amount of the credit if desired. For example, if a credit card obtained has a limit of $500, a client can simply charge $1/month for a cup of coffee on the card and then pay the credit card off, in full, and on time, every single month. This usage is then reported to the credit reporting agencies and will generally increase a client’s credit score significantly over time as each monthly bill (however small) is paid off in full, and on time, each month.

For the reasons stated above, filing for bankruptcy does not always mean a large credit decline upon filing. Furthermore, most former bankruptcy debtors can quickly rebuild credit over a one to four-year period simply by utilizing the steps listed above for credit repair after the debtor’s chapter 7 bankruptcy or chapter 13 bankruptcy case (or less commonly, chapter 11 bankruptcy case) is completed. Many former clients of Nova Law Group have improved their credit scores 100-200 points over a one to four-year period through the above methods and have gradually developed excellent credit over time. While every client’s situation is different and the above methods are effective to different degrees for each client, the above methods can assist all post-bankruptcy debtors with rebuilding credit to a significant extent.

If you are an individual interested in bankruptcy or have questions regarding the credit impact resulting from a bankruptcy case, feel free to contact Nova Law Group and an attorney will be happy to speak with you. Nova Law Group’s office is located in downtown Mountain View, CA, and we serve bankruptcy clients from all over the San Francisco Bay Area, including mid-peninsula cities like Palo Alto, Menlo Park, Los Altos, Sunnyvale, and Los Altos Hills, as well as from the major metro areas of Oakland, San Francisco, and San Jose, including all cities surrounding such metro areas in the greater SF Bay Area. Feel free to contact us regarding your bankruptcy needs and we will be happy to speak with you.