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Credit Score

Bankruptcy and Your Credit Score

Recently, I read an article that surprised me. The article, in Smart Money, addressed the issue of credit scores and the effect of a bankruptcy filing on the score.

People considering filing for bankruptcy have many questions and concerns about the impact of their filing bankruptcy. Among the questions I am often asked about is the impact the bankruptcy filing will have on their credit score. Here is the surprise:

The negative impact on your credit score may not be as bad as expected and in some cases, may not be negative at all!

First, in most, but not all cases, my clients have been struggling with their debt for some time and do not currently have a stellar credit. If there have been repayment problems, charged off accounts, high balances and collections, the fact is that your credit score is not great. So what does a bankruptcy filing do to the score in that situation?

For starters your credit report gets a cleansing. Your high balances are going to be removed, your late payments are going to be removed and your records of unpaid debts are going to be removed. In their place your credit report will report these debts as “included in Chapter 7 Bankruptcy” or “included in Chapter 13 Wage Earner Plan,” depending on the chapter of bankruptcy that was filed.

Over the long run the credit score may further benefit. This is because when the credit score is calculated, the FICO formula developed by the Fair Isaac Company (the most widely used credit scoring formula) is put together in such a way that it compares consumers in similar financial situations. Fair Isaac divides consumers into 10 groups, using what it calls “score cards.” It then ranks the consumers in each group based upon the others in the group. One of the groups is bankruptcy filers.

So, when you file a bankruptcy case your credit score is determined based upon how you do when compared with other people who have filed bankruptcy. You are more fairly compared. You are not being compared to people with impeccable credit credentials.

You are not going to be able to achieve a perfect 850 credit score while you still have a bankruptcy appearing on your credit report, but the FICO spokesman quoted in the article indicated that with good credit management after the filing of your case, credit scores in the 700’s were not impossible.

Another recent report indicated that an increase of 60 to 71 points in an individual’s credit score was occurring following a bankruptcy filing. I am not saying you should file bankruptcy to increase your credit score. An increase may not occur in your case in any event. What is indicated that the impact may in fact not be nearly as severe as previously thought.

To get your credit score back up after your bankruptcy filing, be certain that all of your accounts included in bankruptcy show that they were in fact included in the bankruptcy filing and now indicate $0.00 balances. A creditor should NOT be reporting the account as “delinquent” after the bankruptcy case. Your credit will suffer. You can take steps to correct this misreporting by the creditor.

As soon as your bankruptcy case is over get a credit card and start making on time payments. If you can not get an unsecured card, get a secured card (you make a deposit with the credit card issuer which will serve as your credit limit). As you make on time payments you will receive offers for unsecured cards. Be very, very careful in your usage of the credit cards. You are trying to rebuild your credit, not repeat mistakes of the past.

Auto loans are available right out of bankruptcy. Your local bank might turn you down but the finance manager at the dealership will find financing for you in most cases. Be prudent, shop around. Get the lowest rate. Ask yourself, “do I really need to incur new debt right now?” If you wait to finance a car until you begin rebuilding your credit your interest rate is likely to be lower.

As I write this the mortgage market is a mess. The sub-prime mortgage market imploded and arguably no longer exists. Traditionally, mortgage lenders were willing to write mortgage loans after two years of on time credit payments following bankruptcy. Only time will tell what will occur with the mortgage market as it goes through it’s correction phase.

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