Does Bankruptcy Ruin Your Credit?

Bad credit results in negative entries in the debtor's credit bureau files. TransUnion, Experian and Equifax -- the three main national bureaus -- record financial actions, including if someone opens and closes accounts, makes on-time or late payments, or faces car repossessions, property foreclosures and bankruptcies. Credit is hurt by declaring bankruptcy, but the exact effect on an individual's credit report depends on multiple factors.

Definition

Bankruptcy is a court action that eliminates a person's debts or creates a special repayment plan, depending on the type. The Federal Trade Commission explains that Chapter 7 bankruptcy is the more radical filing because it forces liquidation of most assets and gets rid of most debts. Chapter 13 bankruptcy allows the filer to keep more possessions and requires repayment of certain debts.

Time Frame

Both Chapter 7 and Chapter 13 bankruptcies stay in consumer credit files for 10 years. Equifax, Experian and TransUnion include bankruptcy records in credit reports for that entire time, and the bankruptcy notation is seen by anyone who orders those reports. People can file bankruptcy more than once, although they must wait at least two years between Chapter 13 filings and eight years between Chapter 7 cases.

Effects

Bankruptcy is a negative on any credit report, but most people who declare bankruptcy already have low credit scores, according to Rod Griffin of Experian, so their numbers are unlikely to drop much farther. It is hard to get loans and credit cards immediately after the bankruptcy, but the credit score rises if the person handles new accounts responsibly. Lenders see a history of recent on-time payments as a sign that the person is sincere about rebuilding a good record.

Solution

MSN Money financial columnist Liz Pulliam Weston advises that consumers can recover from the most drastic bankruptcy effects within a year or two. The process involves getting new accounts and always paying them on time. People who cannot get regular credit cards might qualify for secured accounts , which require them to deposit a few hundred dollars with the creditor. Those funds act as collateral and guarantee repayment of credit card bills. The issuing bank converts the account to a traditional card within a year or two if it is repaid as agreed.

Alternatives

Several alternatives to bankruptcy do not stay on credit reports for as long and have milder effects on credit ratings. Creditors often negotiate directly with consumers who are having financial problems to create manageable repayment plans. Even auto loan and mortgage companies may be willing to work with people, the FTC explains. Credit counseling firms offer third-party assistance with budget creation, debt negotiation and repayment plans.