What Happens to Your Credit When Going Bankrupt?

Bankruptcy is a court action that provides protection from creditors by either discharging debts or dictating a repayment plan. Bankruptcy Abuse Prevention and Consumer Protection Act statistics from the United States Courts show that almost 1.4 million people filed for bankruptcy in 2009 to relieve themselves of consumer debts. This action may relieve repayment pressure, but it also devastates the filer's credit reports and score.

During Bankruptcy

The bankruptcy process stops creditors and collection agencies from harassing you for repayment because they must stop contacting you once you notify them of your bankruptcy filing. This court action also halts foreclosures, car repossessions and utility turn-offs, according to the Federal Trade Commission, or FTC. All of these negative entries still appear on your credit reports and impair your ability to open more accounts.

After Bankruptcy

Bankruptcy either wipes away most of your debts if you filed Chapter 7 or makes a court-approved repayment plan if you filed Chapter 13, the FTC explains. This process does not automatically restore your credit. The bankruptcy is reported by the credit bureaus for 10 years, where it is visible to everyone who requests your report. MyFICO, the website for the largest credit score firm, advises that bankruptcy lowers your score. The impact is worse for people who start out with good credit, but most see less of an effect because their scores are already damaged by the financial problems leading up to the filing.

Recovery

Bankruptcy does not hurt you badly for the entire 10 year reporting period if you manage your finances properly afterward. The law forces you to undergo credit counseling before filing and budget training afterward, according to the FTC. Your credit score goes up if you use your new knowledge to build a history of appropriate credit use and on-time payments. Liz Pulliam Weston, a MSN Money website writer, states that you may have to start with a secured credit card account. You deposit enough money to cover the credit limit, which may be as low as $300, and the bank keeps that as collateral. It reports your activity to the credit bureaus and your account is usually converted to a regular credit card if you pay on time for one to two years. Your good record helps you open other accounts and loans, which also help you if you keep the balances down and make timely payments.

Alternatives

The FTC explains that there are alternatives to bankruptcy which have a less severe impact on your credit. Late payments have the worst effect, according to MyFICO, so making a budget that allows you to catch them up and keep them current improves your credit rating significantly. A credit counselor can help you if you are unable to make a workable budget on your own. Most counseling agencies also create formal debt management plans if you need more extensive help. Your late payments, charged-off accounts and other negatives look bad, but they disappear in less time than a bankruptcy. Most delinquencies are erased in seven years.