Credit scores have become an omnipresent part of our lives—your credit score can affect whether you can get a credit card, rent an apartment, qualify for a mortgage, or even get a job. It is understandable, then, that most people will want to know how a particular financial decision will affect their credit score. This is also true when it comes to bankruptcy. The impact of bankruptcy on your credit score can sometimes be an important factor in the decision to file for bankruptcy.

The short answer to the questions “Will bankruptcy affect my credit score?” is “Yes.” However, how your credit score will be affected depends on your situation and a number of different factors. Because of the manner in which credit scores are calculated, it is impossible to determine the exact impact of bankruptcy on the credit score of any particular individual. But it is possible to provide a sufficient explanation of how credit scores are calculated, to allow a person to make an educated decision when filing for bankruptcy, and to help with credit rebuilding after bankruptcy. This article answers the most common questions about credit scores and bankruptcy.

What is a Credit Score?

A credit score is, very simply, a number that allows potential lenders to determine your credit risk—how much you can afford to borrow and how likely you are to repay the loan. A credit score is not determined by any law. Rather, a credit score can be based on any number of conceivable factors, and in principle, any person or company can come up with its own method for calculating a credit score. In practice, however, most lenders, and all credit reporting agencies, have come to rely on what is known as the FICO score. “FICO” stands for Fair Isaac Corporation, a data analytics company that over decades has become the overwhelmingly dominant provider of credit scores in the United States. The manner by which FICO calculates credit scores is proprietary to it. This means that the manner by which FICO calculates credit scores is not publicly known, except to the extent that FICO chooses to share information about its methods. There is federal laws that regulate what can be included in a credit report, such as the Fair Credit Reporting Act, but the restrictions imposed by these laws are fairly limited.

Because FICO scores are what most people think about when thinking about credit scores, when this article talks about a “credit score,” what is meant specifically is the FICO credit score.

How Is the Credit Score Calculated?

A credit score is calculated using information from various sources, including information supplied by creditors, and publicly available information. According to FICO, it uses five different categories of information, with each making up a different percentage of the overall score. These five categories are:

  • Payment History (35%)—this category looks at whether you’ve paid your accounts on time, and is considered the most important factor.
  • Amounts Owed (30%)—this category looks both at how much you have in total debt, and how much your debt is relative to your available credit. As a simple example of what this means, it is better to owe $500 on a credit card with a $2,000 limit, than it is to owe $500 on a credit card with a $1,000 limit.
  • Length of Credit History (15%)—this category looks at how long you have had your credit accounts, including the age of your oldest account, the age of the most recent account, and the average age of your accounts.
  • New Credit (10%)—this category looks at how many of your credit accounts are new, or recently opened. Opening several accounts in a short period is generally a negative.
  • Credit Mix (10%)—this category looks at the types of credit accounts you have, such as credit cards, store cards, mortgages, car loans, student loans, etc. Generally, having both “revolving accounts,” like credit cards, and “installment accounts,” like mortgages or car loans, is better.

There is a caveat to the above percentages, however. FICO states that although these percentages apply for the general population, the relative importance of each category may be different for any particular individual. For example, according to FICO, scores for people with shorter credit histories may be calculated differently from scores for people with longer credit histories.

Your credit score will also be affected by “hard credit inquiries,” or inquiries made by creditors when you apply for credit. These inquiries will affect your score for 12 months after they are made.

It is also worth mentioning that certain factors are not considered in calculating your credit score. These include:

  • Your age
  • Your salary and occupation
  • Your job, employer, and employment history
  • Where you live
  • The interest rates charged on your loans and accounts
  • Child and family support obligations

How Does Bankruptcy Get Categorized in Calculating the Credit Score?

Bankruptcy gets categorized under the Payment History category when calculating your credit score. But the impact that the bankruptcy will have on the credit score will differ from individual to individual. Generally speaking, the higher your credit score is before bankruptcy, the more it will drop as a result of bankruptcy. Since most people filing for bankruptcy already have low credit scores, bankruptcy will likely have little impact on their credit scores.

How Long Will Bankruptcy Stay on My Credit Report?

The length of time that a bankruptcy can stay on your credit report is one of the few things regulated by federal law. Under the Fair Credit Reporting Act, bankruptcy cannot be reported for more than 10 years. This time period is usually calculated from the date the bankruptcy is filed.

There are exceptions to the 10-year limit when the credit report is being provided in connection with (1) a loan of $150,000 or more, (2) a life insurance policy of $150,000, or (3) employment at an annual salary of $75,000 or more. However, as a practical matter, credit reporting agencies will normally remove a bankruptcy from your credit report after 10 years.

Although federal law does not differentiate between the different types of bankruptcy for credit reporting purposes, FICO does. Chapter 7 and Chapter 11 bankruptcies are reported for 10 years. However, Chapter 13 bankruptcies are only reported for 7 years. Therefore, there may be a slight advantage in filing a Chapter 13 bankruptcy when it comes to the impact of the bankruptcy on your credit score.

How Long Will It Take for My Credit Score to Recover after Bankruptcy?

The impact of bankruptcy on your credit score will be reduced on its own over time. The reason for this is that the age of the negative information on your credit report affects its impact on your credit score—the older the negative information, the less impact it will have on the credit score. So, over time, the bankruptcy will have less and less impact on your overall credit score. By the time the bankruptcy drops off your credit report entirely (in 7 or 10 years, depending on the type of bankruptcy), it may already have minimal impact on your credit score.

More importantly, you can significantly improve how fast your credit score recovers after bankruptcy. To do this, it is important to re-establish a positive credit history. One of the simplest ways to accomplish this is through the use of credit after bankruptcy and timely and regular payments on the credit account. The credit could be in the form of a credit card (even a secured credit card), a car loan, or even a mortgage. (If you had the car loan or the mortgage before you filed for bankruptcy, you will likely need to enter into a “reaffirmation agreement”—doing so has risks, so consult with your bankruptcy lawyer before making this decision). The idea is not to get into more debt after bankruptcy, but to establish a good payment history. Remember, payment history is the most important category in determining your credit score. Remember also to keep your credit card balance low relative to the card limit. In short, if you are proactive in re-establishing a positive credit history, and avoid further negative entries on your credit report, you can significantly expedite the recovery of your credit score after bankruptcy.

Will I Be Able to Get Credit After Bankruptcy?

The short answer is yes, you will be able to get credit after bankruptcy. And you will not need to wait 7 or 10 years to do so. Of course, how soon you will be able to get credit will depend on a few factors, in particular on the type of credit you are looking to get. Credit cards are usually the easiest. It is not uncommon for people to be bombarded with credit card offers shortly after filing bankruptcy. Of course, these cards may have high interest rates. However, if you have just completed a bankruptcy, you want to avoid getting into more debt, and therefore do not want to use a credit card for long-term financing. The only purpose of a credit card immediately after bankruptcy should be to establish a positive payment history, and to accomplish this it is best to pay the balance in full every month. And if you pay the balance in full, the interest rate becomes irrelevant.

Car loans tend to be slightly more difficult to get after bankruptcy, but your ability to qualify for a car loan will likely vary widely depending on where you seek financing. Banks may have more stringent requirements. On the other hand, you may be able to get in-house financing from a dealer, or from an auto lender. You should expect, however, to pay a high interest rate on an auto loan that you obtain shortly after bankruptcy.

Mortgages may be the most difficult to obtain among the common types of consumer credit. It may take several years after bankruptcy to qualify for a conventional mortgage. However, numerous other factors may have greater impact on your ability to obtain a mortgage, such as your income, whether you have a co-borrower, and the amount of the down payment. Furthermore, if you are applying for a FHA-guaranteed mortgage, or are using another government program, you may be able to qualify shortly after bankruptcy.

Conclusion

Bankruptcy will likely have some impact on your credit score. But, for most people considering bankruptcy, that is a small price to pay for eliminating thousands or tens of thousands in debt, and avoiding years of financial struggle. Nevertheless, each person’s situation is unique, and it is important to carefully consider all relevant factors before deciding to file for bankruptcy. If you are in Arizona, and would like help determining whether bankruptcy is the right option in your situation, Yusufov Law Firm can help guide you and provide legal advice on the legal ramifications of your decision. To schedule your free consultation with an Arizona bankruptcy attorney, please call 480-788-0098 in Phoenix/Mesa or 520-745-4429 in the Tucson area.

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