Will Bankruptcy Ruin Your Credit Forever?
Bankruptcy is generally regarded as one of the most intense financial situations someone could find themselves in—a true last resort for those in legit economic dire straits.
And while it is scary and potentially devastating, it isn’t the end of the road.
“It’s more respected now for what it is: a fresh start,” says Robbin Itkin, a partner at DLA Piper who specializes in bankruptcy law. “If people are filing because they have financial issues, it will enable them to get these debts off their plate and build themselves back up.”
Bouncing back from bankruptcy is possible, but the impact on your credit is likely to be substantial for a very long time without a conscious effort to get back on solid financial footing. To shed more light on this, we talked with bankruptcy experts to find out the impact of bankruptcy on your credit score and the best way to go about repairing the damage in its aftermath.
How Much Will Bankruptcy Affect My Credit?
A bankruptcy will lower the average consumer's credit score by approximately 100 points, says Florida consumer protection lawyer Donald Petersen. But this will also depend largely on what your credit looked like before filing.
Bankruptcy doesn’t reset your credit, either. If you had a bad score before, that will follow you post-bankruptcy. But a score that was high before filing will be slightly less challenging to rebuild after a bankruptcy-related drop. After all, you’re sacrificing your good credit for the chance to get out from under crippling debt—and that won’t be without consequence.
How Will Bankruptcy Impact My Life?
Make no mistake, a bad credit score can negatively affect almost all facets of your life. And the impact isn’t short-lived, either. Filing bankruptcy and the low score that brings will likely follow you for years.
Money Crasher’s financial expert David Bakke says that bankruptcy’s impact on credit will “generally be severe and rather long-lasting—to the tune of at least seven years.”
You might also see it reflected in other parts of your life.
“Something a lot of folks don't know is that a bankruptcy can drive up your car insurance rates too,” adds Bakke. “In addition, there are plenty of times when you'll go to do things you think are rather minor—for example applying for a driver's license—and you'll be asked the question if you've ever filed for bankruptcy.”
And while Bakke says bankruptcy may not preclude you from getting a credit card or car insurance, it likely means you'll have some explaining to do.
Will Bankruptcy Erase All My Debt?
No. Only certain debts will be discharged in bankruptcy—and at the huge cost to your personal credit mentioned above.
However, other unrelated forms of debt will remain. If you had student loans before your bankruptcy, they’ll be right there waiting for you even after your declaration unless you can show the bankruptcy court that repayment will “impose an undue hardship” on you and your dependents. Same with alimony, certain taxes, certain governmental fines and penalties, and more.
Mind you, this isn’t an entirely bad thing. Continuing to pay down these debts during bankruptcy can actually help you rebuild your credit, as your creditors will be reporting your activity directly to the credit reporting agencies that determine your credit score. This is a good way to start clawing back those lost points on your credit score without having to apply for a high-interest loan or a credit card with a towering APR.
However, debts you’ll want to let go of may include debts secured by assets that depreciate quickly. This could include your car if you financed it and have substantial negative equity in it—yet another reason car loans often don’t make economic sense.
“It is not worthwhile for a debtor to reaffirm a car that they have substantial negative equity in,” Petersen says.
Can You Bounce Back From Bankruptcy?
Yes. In fact, it is entirely possible to get yourself back in even better financial shape than you were before the bankruptcy—provided you’re able to adopt a healthy financial approach to the recovery.
And the first key to this approach is treating bankruptcy as a last resort instead of a quick escape.
After all, you’ll likely be feeling bankruptcy’s effects for the better part of a decade or more. Instead of returning to your normal financial activities, you should take drastic action to pay down your debts and treat bankruptcy’s aftermath as a real opportunity to turn your bad financial situation around.
“Credit scores can be fixed by being a good citizen, getting other cards and paying your debts,” she adds. “Being honest and communicating with your creditors is critical.”
It can be a trying time, but experts say that with diligence and a discipline, you might just come back stronger financially in the long run.
“It’s a process that can help everyone if done correctly and honestly,” says Itkin.