7 common myths about how bankruptcy affects credit

Filing for bankruptcy is devastating to your credit and can drop your credit rating by over 200 points. But for those in dire straits, bankruptcy is a last resort that can help them liquidate assets, write off or pay off debts, and gain financial relief.

If you are considering bankruptcy, you need to understand how it will affect your credit. It involves dispelling some common misconceptions about how bankruptcy affects your credit.

Myth # 1: If you don’t have negative information on your pre-bankruptcy credit report, you will have a higher post-bankruptcy credit score than if your report contained negative pre-filing information.

The truth: A positive payment history and lack of negative information does little to minimize the impact of bankruptcy on your credit score. The presence of bankruptcy and the length of bankruptcy on your report are the most determining factors

Myth # 2: All bankruptcy information stays on your credit report for 10 years, no exceptions.

The truth: Only the public record of a Chapter 7 bankruptcy lasts 10 years. All other bankruptcy references remain on your credit report for seven years, including:

  • Trade lines indicating “account included in bankruptcy”

  • Collection debts from third parties, judgments and tax liens released by bankruptcy

  • Chapter 13 elements of public record

Once the above items start to go away, you may see a bigger increase in your credit score.

Myth # 3: You will have bad credit as long as the bankruptcy information remains on your credit report.

The truth: While you should expect a significantly lower credit score after bankruptcy, you can start rebuilding your credit with smart credit management. After four or five years, you may even be able to hit the right credit score range (700-749). After bankruptcy, you can immediately start rebuilding your credit by:

  • Add new credit, such as secured credit cards or small installment loans, to compensate for negative information on your credit report

  • Make payments on time for all debts, new and old

  • Keep your credit card balances below 30% usage

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Myth # 4: Bankruptcy also affects the credit of all consumers, regardless of the amount of debt or the number of debts included.

The truth: Your credit score will take into account details such as the amount of debt paid and the proportion of negative and positive accounts on your credit report. If you have a relatively low amount of debt and only a few accounts are included in your bankruptcy, your credit score will be higher than that of someone with more serious bankruptcy.

Myth # 5: All bankruptcy debts will be cleared from your credit report.

The truth: While bankruptcy can help you clear or pay off your past debts, these accounts won’t disappear from your credit report. All bankruptcy-related accounts will remain on your credit report and affect your credit score for seven to ten years, although their impact wears off over time.

Also, federal student loans often cannot be discharged in bankruptcy, so you may still be forced to pay them.

Myth # 6: You cannot get a credit card or loan after bankruptcy.

The truth: Credit cards are one of the best ways to build credit, and there are options for those with checkered credit histories. Secured credit cards, which require an initial security deposit, have a lower barrier of entry but spend and accumulate credit like a traditional card.

Likewise, there are loans available, such as passbook, CD, or credit loans, which are secured by a deposit or collateral and will help you build credit as you pay it back. Like secured credit cards, these loans are much easier to obtain because the lender is protected in case you cannot pay.

Myth # 7: Bankruptcy will ruin your credit forever.

The truth: Bankruptcy will cause serious damage to your credit in the short term, but it will only stay on your credit report for up to 10 years. After that you are free and clear. And if you continue to practice good financial habits and build credit in the meantime, you can rebuild your credit to be stronger than ever.

So before you take the plunge into bankruptcy, see a bankruptcy lawyer, and learn the facts about how credit scores deal with bankruptcy. You may be able to minimize the damage and speed up your credit recovery after you deposit.

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