How Filing for Bankruptcy Affects Your CreditIf you’re being crushed by mountains of debt, filing for bankruptcy can be a way to get your life back together. However, it comes with a steep price; not just in the payments you have to make or the assets you may have to sell, but in what it does to your credit. Bankruptcy can devastate your credit scores in the short term, but the total damage it does long-term depends on a number of factors. To see how your credit might fare after a bankruptcy, read on.

What is bankruptcy?

Bankruptcy is a legal process that can give people and businesses who are swamped with their debts a fresh start, while letting creditors collect a portion of the debts they’re owed. It discharges some or all of your debts, meaning you no longer legally have to pay them (though there are some exceptions for debts that cannot be discharged, such as alimony and student loans), and in return the court orders you to pay your creditors back as much as you can, using a method that depends on the type of bankruptcy you file for. The two types of bankruptcy available for individuals in the U.S. are Chapter 7 and Chapter 13. Chapter 7 bankruptcy requires you to sell off some of your assets and use the proceeds to pay as much of your debts as you can, then discharges your remaining debts. Chapter 13 bankruptcy lets you keep your assets, but makes you set up a repayment plan over three to five years with a trustee that the court appoints, and at the end of that repayment period, your remaining debts are discharged. One good thing about Chapter 13 is that it automatically consolidates your debt, but you have to have a regular stream of income to qualify for it.

How does bankruptcy affect credit?

Filing for bankruptcy often hurts your credit scores pretty badly, but exactly how bad it hurts hinges on a couple variables, starting with your pre-bankruptcy credit scores. The higher your credit scores are to begin with, the more points you’ll lose from bankruptcy. For example, one bankruptcy law firm estimates that people with scores of 780 will suffer hits around 220 to 240 points, while people with scores around 680 will only drop 130 to 150 points. Another factor is the number of accounts from which you’re discharging debt, with more accounts translating into a bigger hit.

However, not everything about filing for bankruptcy is bad. Your credit scores may take a beating in the short-term, but there’s definitely a light at the end of the tunnel. First of all, once you file for bankruptcy, creditors and debt collectors have to pause collection efforts while the case is pending in court, which can buy you some valuable breathing room if they’ve been hounding you. Second, while previous missed payments stay on your credit history for a number of years, you get to avoid further damage since you don’t have to pay any debts that get discharged, which can help you break out of a debt cycle that has been slowly dragging your credit down. Keep in mind that debt collectors may still try to collect discharged debts, even though they know you don’t legally owe them money. Finally, the credit impact from a bankruptcy fades on its own over time until it falls off your credit history completely, either 10 years later if you filed a Chapter 7, or seven years later if you filed a Chapter 13.

How to mitigate the damage of bankruptcy

If you’re filing for bankruptcy, there are a few things you can do after your case has concluded to help recover your credit as fast as possible. As tempting as it is to swear off credit after a bankruptcy, your scores will never recover unless you establish some new positive history. It may surprise you to learn that many creditors will still do business with you after a bankruptcy, partially because after filing for bankruptcy you have to wait several years before filing again. You may not have access to their best interest rates and offers, but at the very least you can get a secured credit card to help you safely build your scores. You should also comb through your credit reports to make sure no creditors or collectors are still adding negative items related to your discharged debts, or hire a credit repair service to clean up your credit for you. Lastly, creating a budget to live below your means will help you avoid getting into more debt, and will help you make the most of your clean slate.

Rebuilding your credit can be a long, tough journey, but there is a life after bankruptcy. For more articles on how to recover after a big life event, check out our personal finance blog.