Bankruptcy will rarely help your credit in the short term; however, it can be a useful tool over a more extended period. Not only will it resolve debts such as credit card balances, medical bills, and personal loans, but it will give you the fresh start you need to rebuild credit anew.
Most people file bankruptcy to get relief from overwhelming debt. Unless you’re one of a handful of people able to keep current on all of your obligations, your credit score will reflect your struggle to make timely payments on high-balance accounts. And your credit score is likely to be low.
Although it’s likely that your credit score will fall further when you file a bankruptcy case, it doesn’t make as much difference as you might think. Most people can expect their post-bankruptcy score to be in the 530-560 range, regardless of where it was to start. In fact, debtors (that’s what we call people who file bankruptcy) report that regardless of the score beforehand, it hovers around 550 after filing for bankruptcy.
The conventional wisdom is that lenders prefer to see that a person filed a Chapter 13 bankruptcy rather than a Chapter 7 case. The perception is that you make an effort to pay back at least some of what you owe when you file for Chapter 13 bankruptcy. However, an important factor when considering whether Chapter 13 works to your advantage in rebuilding your creditworthiness is timing and the length of the process.
A Chapter 7 bankruptcy will only last four to six months before you receive a discharge (debt forgiveness). After it’s over, you can start immediately putting steps in place that will help you rebuild your credit.
By contrast, a Chapter 13 case will last from three to five years before you receive a discharge. It’s entirely conceivable that if you filed for Chapter 7 bankruptcy, you could have already improved your credit, or pushed your credit score into the good or even excellent range, literally years before finishing a Chapter 13 case.
Learn more about commonly-filed bankruptcy chapters in Chapter 7 Bankruptcy vs. Chapter 13 Bankruptcy.
Although a Chapter 7 case will stay on your credit for ten years (seven for a Chapter 13 matter), the bankruptcy’s impact will diminish as time passes. In fact, you might not realize that you could be rebuilding your credit even while your bankruptcy case is pending.
For instance, if you have a car loan or a mortgage, and you’re going to keep the property after bankruptcy, you’ll keep making those payments. Your lenders will likely continue to report the payments to the credit bureaus, especially if you’ve signed a reaffirmation agreement (but this isn’t always the case—check with your attorney).
You might also be surprised to discover that some lenders actively market to recently discharged bankruptcy debtors. They view you as a good bet because you’ve eliminated much of your debt and you can’t file a Chapter 7 bankruptcy again for eight years. The credit will cost you more in interest for some time, but many people who have used their new credit carefully find that their scores significantly improve in just two or three years.