If you are drowning in debt and it seems like you can’t get ahead, bankruptcy may be a tempting option. But before you start down the path of bankruptcy, it is important to understand how bankruptcy harms your credit and the long-term ramifications. It takes a full decade to clean up your credit from a bankruptcy, if not more. Let’s take a look at how bankruptcy ruins your credit and how you may be able to avoid it.
What bankruptcy does to your credit
Bankruptcy is a court procedure for people and businesses who can’t repay their debts. Typically bankruptcy is a last resort for borrowers who have far more debt than they can repay. Bankruptcy can impact credit card debt, medical collections, and other amounts owed.
When someone files for bankruptcy, they typically need a lawyer (not inexpensive) to guide them through the slow bankruptcy and debt discharge process. But while bankruptcy may lower your debt load today, it has huge ramifications for your credit. It is also important to note that in nearly all cases, bankruptcy will not affect student loan balances.
Bankruptcy will likely drop your credit score by at least 100 points, and it takes a full 10-years before a bankruptcy is removed from your credit report. This may prevent you from getting approved for new credit cards, mortgages, and other loans. And if you do get approved, you will likely pay a far higher interest rate than those who don’t have a bankruptcy on their credit report.
A bankruptcy is a public record, a section on your credit report. In most cases, if you are facing bankruptcy your credit score has likely already taken a bit of a beating. But most negative on your credit report goes away in seven years outside of the dreaded bankruptcy.
If turning your credit around is a top goal, bankruptcy is generally a bad option. You are much better off if you can resolve your debts with other means. If you do go the bankruptcy route, it is a long path to credit score and credit report recovery.
Recovering from bankruptcy
If you already declared bankruptcy, rebuilding your credit is a slow but important process. The process of rebuilding your credit after bankruptcy typically takes ten years, but you can start with some steps to shore up your credit report with a positive account.
In many cases, that means starting with a secured credit card to rebuild your credit score. Most important, always make 100% on-time payments going forward. If you want to rebuild your credit after bankruptcy, it is vital to follow credit best practices. That means never missing a due date, keeping your balance paid off, and avoiding the debts that led to bankruptcy in the first place.
While you work to maintain perfect records for your new accounts, do your best to resolve your outstanding debts, collections, and other negative information on your credit report. Every little bit helps, but no matter what you do it is going to take quite a bit of patience as your score slowly climbs from bankruptcy to the 800+ club.
Strategies to avoid bankruptcy
If all of this bankruptcy talk has you thinking twice about calling up a bankruptcy lawyer, good! Rather than giving up on your repayment quest, it is better to take steps to avoid bankruptcy from the start.
Here are a few strategies you can use to get creditors off your back and get on track for full repayment of your debts:
- Follow the debt avalanche method – The debt avalanche is the fastest way to pay off your debt, and a close cousin of the debt snowball method popularized by Dave Ramsey. The basis of this strategy is to focus all efforts on high interest debt first, and then work toward paying off lower interest debt.
- Settle with your creditors – Call up credit card companies and ask about a debt settlement. In this case, you can make a one-time lump payment to wipe out your debt for good. Creditors may accept an amount lower than your total outstanding balance, so this can save you money. While it may harm your credit, it is far better than a bankruptcy.
- Resolve outstanding collections – If you have anything in collections, try to get them paid or settled. The sooner they are resolved, the sooner the debt collector will be off your back and your credit score can start recovering.
- Keep a long-term focus – Bankruptcy offers a short-term benefit (less debt), but that comes with a long-term cost (lower credit score). Focusing on your long-term credit and financial help will help guide you to the best credit-related decisions.
There are some cases where bankruptcy is the best choice, but those situations are rare and should not be taken lightly. Don’t listen to a scammy lawyer or debt settlement company that pushes you to make a decision that is bad for you but good for them. Put your own needs first and only listen to those who have your best interest in mind.
Bankruptcy is a last resort
Bankruptcy is not simply an easy way out of paying your debts. It is a serious financial decision with long-term costs and ramifications. It could prevent you from buying a new home with a mortgage, qualifying for an auto loan, and leads to higher interest rates for loans when you do qualify.
If you are considering bankruptcy, seriously weigh the pros and cons for your unique personal finance situation. Once you get the bankruptcy train rolling, it is very hard to put on the brakes and the damage to your credit may already be done. Only file if you are absolutely sure it is the right decision for you.
In many cases, bankruptcy is not the right choice. The 100+ point drop in your credit may cost you a lot more over the next decade and beyond than the hassles of debt collections and payoffs today. Keep that in mind as you map out your financial plan with a focus on your long-term financial health.