Back to Basics

Back to Basics: What Happens to My Credit in Bankruptcy?

This is another post in our ongoing series “Back to Basics: Bankruptcy.” This post examines credit issues in the context of bankruptcy.

I hear many objections to bankruptcy from people who really ought to be considering it as an option, but by far one of the most frequently cited objections is this: “I don’t want my credit to be ruined.”

Let’s look at the facts, and try to separate them from the myths:

• Myth: Filing bankruptcy means I’ll never get credit again.

Fact: An entire subspecialty of the credit industry exists solely to extend credit to bankruptcy debtors. In fact, even for non-subprime lenders you may be a more attractive credit risk after filing bankruptcy (especially Chapter 7, which is a quicker process than Chapter 13 plans)

• Myth: My credit will take a huge hit if I file.

Fact: Credit scores do generally take an initial hit upon filing. However, an interesting thing then happens: typically, within a year, filers find that their credit scores have actually risen. (See this report from SmartMoney, “Declaring Bankruptcy Can Improve Your Credit Score.”)

• Myth: Negotiating with my creditors will be better for my credit than filing bankruptcy.

Fact: This one’s a bit more complex to address. Generally speaking, folks who should be considering filing for bankruptcy have a skewed sense of the real state of their credit — typically overstating their credit score as much as 100 points. (Obviously, this is only true for folks who haven’t checked their actual scores — and those in distress who have checked their scores are generally very surprised.) The real hit to credit, then, could well be “continuing to do what hasn’t been working” — i.e., delaying the inevitable.

Bottom line: By all means negotiate with your creditors if you haven’t already, and if you have sufficient income to sustain some sort of payment plan. Then, if it doesn’t work, don’t hesitate to take the next step.

© 2008 SC Bankruptcy & Consumer Law Blog.