Bankruptcy & Your Credit Score

: Reese Baker & Associates

  Filed under: Credit

It is commonly thought that filing a bankruptcy will ruin your credit score. Although generally bankruptcy will have the immediate short term effect of lowering your credit score, the reality is in the long run it generally helps your credit score.

FICO (your credit score) is nothing more than a mathematical formula used by creditors to judge the risk of loaning you money. The lower your FICO score, the higher the risk, and the higher the interest rate. The greatest effect on your FICO score is the number of late payments on your accounts. This component comprises approximately 35% of the formula. More late payments equals a lower score. The other major component of your FICO score is “credit utilization” or the amount of revolving debt (such as credit card or installment agreements) you use. This component comprises about 30% of the formula.

If you have months of missed credit card payments, house payments, car payments, or even a judgment, your credit score is probably not very high anyway. Bankruptcy won’t hurt it that much, if at all. Better yet, a bankruptcy will give you a fresh start, a way to start over without all the relentless credit card debt draining away your finances each month. Finally, generally you can rebuild your credit in far less time than it would take you to pay off all those credit cards.

Once you have gotten to the point of consulting a bankruptcy attorney, the likelihood is something has happened to get you in over your head. Your credit score is generally used for one of two purposes: purchasing a home or purchasing a car. If you already own a home and/or a car, and are saddled with other debts, bankruptcy may be the best alternative to solving your debt problems.

Finally, even with the negative impact of a bankruptcy on your credit report, you can still find someone willing to finance you for that new house, car or T.V. Sure the creditor will charge you a higher interest rate and may monitor your account closely, but you will be able to get financed if you look long enough.

As an example:

John Smith wants to purchase a new Nissan Titan that costs $30,000. He filed a chapter 7 bankruptcy 1 year ago and discharged $85,000 in debt. The bankruptcy is still recent on his credit report so he doesn’t qualify for the “good credit” interest rate of 3%. However, he does qualify for a 7% interest rate on a loan for 5 years. He will pay $5,642.16 in interest at 7% as compared to $2,343.64 at 3%.

Having “good credit” only saves him about $3,300 over the five year period or about $94.00 a month. Compare that additional $94.00 to the savings from what he was paying his credit cards as minimum payments before filing bankruptcy and the benefit is clear. Additionally, he will never need to repay any of the $85,000 because it has been discharged in a bankruptcy.

Bankruptcy is a serious financial decision but for most the benefits far outweigh the costs. Contact us today for a free consultation and speak with one of our experienced bankruptcy attorneys.

Written by Patrick J. Gilpin, Jr., Attorney