Many people are struggling to climb out of debt but are afraid to file bankruptcy because they believe doing so will further damage their credit. However, the truth is that bankruptcy can sometimes actually help your credit score.
If you are struggling with debt, your credit score has likely already been negatively affected. Late payments, high balances, and collections are all factored in to your credit score, and all bring your score down.
With bankruptcy, most of the negative information on your credit report is essentially wiped out. The late payments, unpaid balances, and other negative reports are removed. The balances are also wiped out, so that the consumer’s credit report now shows little or no debt.
The accounts included in the bankruptcy will now be listed as discharged with the particular chapter of bankruptcy filed, such as “Included in Chapter 7 Bankruptcy.” Both Chapter 7 and Chapter 13 affect your score the same way, and because Chapter 7 bankruptcy cannot be filed again for eight years, you may be seen as less of a credit risk soon after being discharged from bankruptcy.
Bankruptcy may also help you increase your credit score for the long term. When the most widely-used credit scores – FICO scores – are calculated, the formulas are designed to compare your credit standing with other individuals in a similar financial position. Fair Isaac, the company that created the formula for FICO scores, divides consumers into 10 groups, and then ranks them against other consumers in the same group. One of these groups is comprised of consumers who have filed for bankruptcy. Thus, once you have filed for bankruptcy protection, your credit score will be based in part upon how you handle your credit and your financial situation as compared to others who have filed bankruptcy, as opposed to comparing you to someone with a spotless credit history.
Individuals who decide to file bankruptcy should do so knowing it isn’t the end of the world when it comes to their credit score. Those who have filed for bankruptcy can have vastly different credit scores, and while a perfect 850 credit score is impossible while the bankruptcy is still on your credit report, managing your credit effectively after you file can make it possible for you to achieve a score in the 700s again.