Disclaimer: This article is not legal advice. Any legal information is not the same as legal advice, where an attorney applies the law to your specific circumstances, so you should consult an attorney if you’d like advice on your interpretation of this information or its accuracy. You may not rely on this article as legal advice, nor as an endorsement of any particular legal understanding.
Bankruptcy can be a scary word. There are many misconceptions about what bankruptcy is and what bankruptcy does. While often a difficult decision, filing for bankruptcy may be the most responsible choice a person or business can make. This filing should be done, however, with full knowledge of the process and the effects this may have on a credit report.
What is bankruptcy?
In short, bankruptcy is a legal filing. Bankruptcy proceedings are filed in federal court as a method to resolve unpaid debts and minimize the consequences of these debts for both the filer and the creditors. All bankruptcies must be filed according to the official U.S. Bankruptcy Code. It is generally not advised to file for bankruptcy if a person or party has other methods of paying back debts such as a payment plan.
Bankruptcy may be filed by an individual, a married couple, or a company. The filer is often called the debtor or petitioner. The purpose of the filing is to allow the debtor to rid themselves of financial obligations they simply can’t pay, called a discharge while distributing assets that the debtor does have in an effort to at least partially pay the parties owed, often called creditors.
One way to think of the process is that a bankruptcy is like a divorce from debt. Just as with a regular divorce there is legal paperwork and a redistribution of assets.
Are there different kinds of bankruptcy?
Bankruptcy can take a few different forms, just as most other legal filings. Chapter 15 bankruptcy is typically used in fillings between more than one country while Chapter 12 is reserved for farmers and fishermen. Chapters 7 and 11 are used for business filings and Chapter 9 is for municipalities like towns or utilities.
Individual people will file either Chapter 7 or Chapter 13 bankruptcy. Chapter 7 is referred to as simply Liquidation (Sections 701 to 784). Chapter 13 filings are referred to as Adjustment of debts of an individual with regular income (Sections 1301 to 1330). The bankruptcy filing chosen is typically based on available income and total assets. Chapter 7 can be described as “quick and easy” as the process is generally less complicated and completed within a few months for filing. Chapter 13 seeks to set payment plans and reserve more assets from liquidation but can take 3-5 years to finalize the process.
How these filings affect a credit report, will in part be due to how fast negative collections accounts are resolved and removed from that same report.
What does bankruptcy do to your credit?
Bankruptcy becomes a negative mark on your credit report, drastically reducing your overall credit score. Even a high credit score won’t protect you from the impact of a bankruptcy -- in fact, the higher you’ve climbed, the higher you may fall. Since credit reports and credit scores are all about risk, admitting that a party was a poor risk for payback is essentially a public declaration that this person is not currently a good risk for lending or financing.
Expect to see a good credit score drop by as many as 200 points, and a fair score drop by 130 to 150 points. Exactly how a bankruptcy is filed and the assets involved in the filing will have some impact on how long a bankruptcy stays on a credit report and how the filing affects a score, too. More discharged debt, larger amounts of debt, and lower amounts of paid off creditors are all factors in bankruptcy and credit.
How long does a bankruptcy stay on your credit report?
A Chapter 7 bankruptcy may be the more simple process as assets are liquidated to discharge debt, and even if the debt is not paid off it is considered closed. Because this debt is often unfulfilled however, Chapter 7 causes more complex issues with your credit report, staying on a report for up to 10 years. Again, the number of debts unfulfilled and the amount, will increase or lessen this impact. While the debtor may not need to pay these bills any longer, the debts are still on record.
Chapter 13 bankruptcy involves discharging some debts, and paying others. While this can make the filing more complex, it is generally a more straightforward process when it comes to credit. A Chapter 13 filing will typically be dropped from a credit report in 7 years. In addition, if the debtor is continuing to pay other bills such as a mortgage during this time, they may be able to more quickly repair their credit. A good mortgage payment history is generally an excellent way to increase credit.
During the time a bankruptcy filing is on record, individuals can still work to establish and maintain good credit. Typically a bankruptcy filing will begin to have less and less impact over time, even before the negative remark is removed.
How can you remove a bankruptcy from your credit report?
There is only one way to remove a bankruptcy from a credit report -- time. That said, if you have been building credit for the required 7-10 years after a filing, sometimes these negative remarks don’t get removed automatically. To be clear, these remarks are supposed to be deleted automatically, but verifying this is why it is important to monitor one’s credit.
If that is the case, persons can contact the credit reporting agencies directly and petition for these items to be removed. In addition to removing bankruptcy, there are typically debts associated with these filings that will have been listed as negative remarks on a report. Experian notes that delinquent accounts that were included in a bankruptcy filing should typically be deleted 7 years after discharge of this debt.
How long a bankruptcy stays on a credit report can’t be altered, but there are still many strategies a person can employ to minimize this impact and recover credit more quickly.