Does Chapter 7 Decrease My Credit Score?

Over 1 million people file for bankruptcy each year to get legal protection from creditors, according to the Administrative Office of the U.S. Courts, but they also hurt their credit rating significantly in the process. While bankruptcy is the most disastrous outcome for your finances, it might be the best option for your long-term financial health and creditworthiness. At the worst, you might have to wait several years to get over a bankruptcy, and that might be better than a lifetime of struggling to pay bills.

Identification

All bankruptcies have the same effect on your credit report and score, because filing for any type of bankruptcy requires the borrower to obtain a bankruptcy order to fix his debt load. Chapter 7, however, is the worst bankruptcy you can have on file, because many debts are eliminated and the lender receives nothing--unless his debt is secured by property. A discharge is the least profitable scenario for a lender. Under a Chapter 13 bankruptcy plan the lender gets paid back eventually.

How Much Will Bankruptcy Drop Your Score

Any bankruptcy typically drops your score at least 130 points, even for people who already have a low credit score, according to an April 2010 report on the CNN Money website. If you had an excellent credit score--above 760--your score likely drops to the mid-500s. People who file bankruptcy, however, usually have trouble paying bills on time and have a low score before the bankruptcy filing.

Time Frame

A Chapter 7, and any other bankruptcy, affects your credit score for 10 years, according to the Fair Isaac Corporation, designers of the FICO credit score formula. The effect of bankruptcy on your credit score will be reduced as time passes. It is possible for people to file bankruptcy and become eligible for a mortgage or some other type of credit within two years. Some lenders view bankruptcy as an improvement over your pre-bankruptcy state, because you probably have fewer debt obligations.

Tip

Some debts--such as alimony and student loans--are not eligible for discharge, so you must prepare to pay these off after bankruptcy or you face additional credit damage. To become creditworthy again, you must use credit at some point. Even people with a Chapter 7 bankruptcy on their report may qualify for a secured credit card, which is backed primarily by collateral from the borrower and reported to the major credit rating agencies, according to an article by Liz Pulliam Weston on the MSN Money Central website.