Your Credit Score and Bankruptcy

As a Seattle – Kent bankruptcy lawyer I don’t just help my clients file bankruptcy, I also help them prepare for life after bankruptcy.  One question that I hear a lot is “what will happen to my credit  score if I file bankruptcy?”  Before I answer that question, I just want to address the reason that people ask that question.  The reason that you file bankruptcy is to get a fresh start.  For many people this means being able to buy a car or a house in the next couple of years.  They are worried that the bankruptcy will take care of their debts, but leave their credit score so banged up they still can’t finance anything.  The fact is that many times a bankruptcy is the first step toward improving your credit.

How Is My Credit Score Calculated?

The FICO score or credit score is based on a proprietary algorithm owned by the Fair Issac Corporation.  Basically, Fair Issac owns the rights to a mathematical formula that is used to calculate your credit risk based on certain data inputs.  The formula used to calculate a credit score is a trade secret.  That means that only the Fair Isaac Corporation actually knows how to calculate a credit score.

The Fair Issac Corporation published a basic breakdown of how they calculate the credit score.  (Go To FICO)

  • 35% Payment History – On time payments help, late payments hurt.  As long as you aren’t making the required payment as stated on your most recent bill or statement, you may be getting a late payment report for each delinquent account every month.  These late payment reports rapidly reduce your overall credit score.  Once you file bankruptcy, the creditors are prohibited from reporting any new late payments.
  • 30% Amounts Owed – This is also called the credit utilization ratio.  It looks at your revolving debt, i.e. credit cards, and compares the available credit to the balance due.  For example, if you have a $10,000 credit limit and a $9,000 balance due, the ratio is very high.  If you pay down an account, the overall ratio drops.  Bankruptcy takes all balances down to zero.  It is easier to start at a zero ratio, get a small secured credit card, and pay off the balance in full each month than it is to pay down thousands of dollars in debt in a short time.
  • 15% Length of Credit History – This is a measure of the time since accounts were opened, how long certain accounts have been open, and the last time you used the accounts.  If all of your accounts have been closed and you can’t get any new credit, this portion of the score will drop as well.  Being able to open a couple of new accounts after a bankruptcy allows you to have recent activity, plus a positive payment history.
  • 10% Recent Credit Inquiries and Recent Accounts – Recent applications for a loan or credit card, are noted on the credit report.  Additionally, whether you have any recently opened accounts or have recently reestablished a positive payment history factors in as well.
  • 10% Types of Credit – Managing different types of credit helps your credit score.  Also, certain types of credit are better than others.  A mortgage or car loan are generally believed to be a large help to your credit score.  Still, you need to have a credit card or two; because, the FICO score looks at how you manage all types of credit.  Once you have completed a bankruptcy, it is important to reestablish credit by getting a secured credit card and using it responsibly.  That can help you get a mortgage or a car loan in the future.

What Does A Bankruptcy Do To Your Credit Score Or Your Credit Report?

Your credit score will drop after you file a bankruptcy.  If your credit score started out high, it will drop more than if your credit score was already low.  Then your credit score will usually go back up shortly after the bankruptcy is filed because your credit utilization ratio improves.  You will also start to get offers for credit cards and car loans after you file.  You need to be careful about reestablishing credit.  Make sure that the secured credit card actually reports to the credit bureaus.  Also, make sure that you can manage your new credit, because there is a waiting period to file a new bankruptcy.

A bankruptcy reduces balances due to zero on your credit report.  A bankruptcy does not remove a creditor from your credit report and it does not remove the history of missed payments.  This is because the credit report is showing what happened in the past.  The only way to get a creditor off of your credit report is wait for them to drop off or file a valid dispute with the credit bureaus.  The most important effect of a credit report is that it removes your obligation to repay past debts, and that allows you to start rebuilding your credit.

I Don’t Want My Credit Score to Drop. Should I File Bankruptcy?

Probably.  If you are missing payments, then your credit score is already going down and won’t stop until you do something about it.  If you have trouble paying your bills each month and have no savings, then one large unexpected expense can put you in serious financial jeopardy.

Here’s a common scenario that I see in my practice as a Seattle – Kent bankruptcy lawyer.

If you can make the monthly payments but don’t have any savings, your cards are closed to being maxed out, and you can’t get a new credit card, then one big unexpected expense means that you have to write a check.  Once you write the check for the doctor bill or the car repair, you have to miss a payment to some of all of your unsecured creditors.  But to get caught up, you have to keep using your credit cards for monthly expenses.  That means that you can never get caught up.  Maybe a month or two goes by, and then your creditors start closing your credit accounts.  This series of events triggers a drop in your credit score; and your credit score keeps dropping each month you miss a payment.  This is the downward spiral of debt.  Eventually, it will ruin your credit score and cause huge amounts of stress.

If you cannot pay down your debt and don’t have any savings, then bankruptcy is on option for getting a new start on your financial life.

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