The word "bankruptcy" carries a stigma, but this is not always a fair perception. Many people file for bankruptcy because of unavoidable problems like job loss, divorce or serious medical problems. Sometimes it is the only way to handle a heavy debt load, but it takes a toll on a person's credit score.
Definition
Consumers normally file one of two different bankruptcy types. Chapter 13 is a debt reorganization that lets people keep certain things like their houses and cars. They make a payment plan that spreads the debt over three to five years. Chapter 7 gives consumers a clean slate by wiping away most of their debt, although it does not get rid of child support, alimony or student loans. Both of these court actions look bad to future creditors.
Time Frame
Bankruptcy appears on a person's credit records with the TransUnion, Experian and Equifax credit-reporting bureaus for seven to ten years. Late payments, collection accounts and other unpaid debt show up for seven years. Creditors take these things into account when considering loan and credit card applications. Bankruptcy and delinquencies carry less weight as time goes on if the person's current credit history is good.
Effects
Bankruptcy is always a very negative item on a credit report because creditors see it as a sign of bad financial management. FICO, the largest credit score company, says its impact on each person's score is different, depending on prior history. People who previously had good credit experience the worst impact, while those with low initial scores have only a modest drop. The number of accounts included in the bankruptcy also influences the credit score impact. People with a recent bankruptcy often have difficulty getting new credit or pay higher interest rates to offset the perceived risk.
Considerations
Even though bankruptcy hurts a person's credit score, most people who have to file Chapter 7 or 13 actions already have bad credit, according to Southern Arizona Legal Aid. Bankruptcy adds to those negatives but gives them a chance to rebuild their score with a manageable repayment plan or erasure of their former debt, so it is often the best long-term option.
Solution
Recovery from bankruptcy's effects can begin as soon as the legal process is complete. Liz Pulliam Weston, an MSN Money columnist, advises reviewing your credit reports to make sure accounts discharged in the bankruptcy are not showing up as open and delinquent. AnnualCreditReport.com provides free yearly reports with no purchase obligation.
Pulliam Weston recommends starting to rebuild a good record with a secured credit card. Anyone can get this type of card because it must be guaranteed with a monetary deposit. The issuer will usually convert it to a regular credit card after 12 to 18 months of regular payments. Many lenders will give an auto loan to consumers after bankruptcy because the vehicle secures it, but they charge very high interest. The loan can be refinanced later.
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