Herrin Law

How Does Chapter 7 and 13 Bankruptcy Affect My Credit?

The number one reason why most people never consider bankruptcy is because they think it will destroy their credit and their ability to get credit in the future. But this isn’t true. Bankruptcy is a legal way for you to responsibly address your financial situation.

Most people see a significant increase in their credit score after filing a bankruptcy. The reason for this is simple. Bankruptcy helps drastically reduce and/or eliminate your debt. When you have less debt, it helps improve your credit score.

There are 3 main credit reporting agencies:  Experian, Equifax and Transunion.  Different credit scores use different formulas, but they typically include the following components:

1. Payment History – Estimated 35% of your Score.

Payment history is the most important factor in determining your credit score and accounts for about 35% of your credit score. This means late payments or missed payments have a massive impact on your score.

2. Amounts Owed – Estimated 30% of your Score

How much outstanding debt you have plays a significant role in your credit report. The more debt you have, the riskier you will be in the eyes of a potential lender. This accounts for about 30% of your credit score.

3. Credit Utilization – part of #2.

In addition to the amount of debt you owe, lenders look at how much of your available credit you are using. If you have a $10,000 credit card but your average balance is $8,000, this would be deemed risky since you are using 80% of your available credit. The Credit Utilization score only focuses on revolving credit, which is any credit account that lets you repeatedly borrow money up to a set limit (credit cards, lines of credit). The most available credit you have, the better your credit utilization score will be.

4. Length of Credit History – Estimated 15% of your score.

Usually, the longer you have had an account the more positive it will be for your. Your credit score will take into account how long the credit accounts have been established and how long it has been since you used certain accounts.

5. Credit Mix – Estimated 10% of your credit score.

Your score will take into account the type of credit you have. This includes secured accounts such as a mortgage, vehicle or other secured credit. It also looks at your unsecured credit accounts (credit cards, personal loans, retail accounts). Usually, its good to have a mix of different credit accounts.

6. New Credit – Estimated 10% of your credit score.

This relates to #4 above. If you open up too many accounts in a short period of time, it will have a negative impact on your credit score.

HOW BANKRUPTCY AFFECTS YOUR CREDIT SCORE

Usually, if you are considering bankruptcy, you are already dealing with negative credit issues that drop your score. The two biggest areas are 1) Payment History and 2) Amount of Debt.

Chapter 7 Bankruptcy:

When you file chapter 7 bankruptcy, the process typically takes 90 to 100 days. At the end of that period, you receive a Discharge Order, which legally discharges your debt, meaning that the debt no longer exists. Once this is done, the credit reporting agencies will update your report to reflect the bankruptcy and will reduce your balances to $0.00. Some credit reports completely delete the prior payment history, others will still report the payment history but show your balance as $0.00.

As a result, the Amounts Owed is drastically reduced, which can substantially help your credit score. In addition, as you establish new, positive credit, your score will continue to increase.

Many of our clients are able to get to a 700 credit score 12 months after their discharge. Also, 2 years after the discharge, a person will be eligible to purchase a home (assuming they have the appropriate income and credit score).

Chapter 13 Bankruptcy:

A Chapter 13 bankruptcy takes anywhere from 3 to 5 years to complete. Upon completion you receive your discharge. However, most creditors will freeze reporting to your credit once you file a Chapter 13.

While in the Chapter 13, the key is to ensure you make your bankruptcy payments on time. Most clients start seeing an immediate improvement in their credit score after filing the bankruptcy. In addition, you are still eligible to purchase a home or refinance a home. Usually lenders require that you be in the Chapter 13 for at least 12 months with consistent payments.

Our office routinely sees existing Chapter 13 clients get approved to purchase a home and/or refinance an existing home, while still in their Chapter 13.

A recent client was approved to purchase a home June 2021. He filed his Chapter 13 case in early 2019. When he filed the Chapter 13 case his FICO score was at a 506. A little over 2 years later when he was approved to purchase a home, his FICO score was 628.

Another client recently completed the Chapter 13 and received a discharge.  Four months after the discharge her FICO score was at a 700.

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If you want to discuss your financial situation in more detail you can call 469-607-8552 or use our online contact form and set up your free financial strategy session (30 minutes). Also, if you decide to hire my law firm and mention this blog, you will receive a 10% discount on your fees.

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