How Does Bankruptcy Impact Your Credit Score & How to Recover

Rebuilding credit after bankruptcy can seem impossible. Learn how long bankruptcy affects your credit and ways to improve your post-bankruptcy credit score.

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Personal bankruptcy, the pneumonia of financial conditions, is without a doubt a serious setback, and you’ll feel its weakening effects on your finances for a while.

But bankruptcy isn’t uncommon (more than 500,000 Americans file annually), and it doesn’t have to be fatal. Your financial life isn’t getting buried; by discharging and/or reorganizing your debt, you’re seizing the opportunity for rebuilding your credit in a way you can be proud of.

Bankruptcy is a fresh start for a debtor,” says Cathy Peek McEwen, a Federal Bankruptcy Judge for the Middle District of Florida. “That’s the pep talk I give my law students, and to everyone who comes into my courtroom.”

In fact, by following a handful of proven methods, you can begin to repair your credit almost immediately. Even though bankruptcy can linger on your credit report as long as 10 years, if you stick with the plan, you could be back in the market for a car loan or even a home mortgage in as few as two years.

Your Credit Score after Bankruptcy 

Think hard on any decision involving bankruptcy, because when you commit to it, your credit score is going to take a whack. Before you commit, know that you have done all you can to climb out of your debt hole: tough, tight budgeting; taking a second job or doing freelance/gig work; selling off assets; consulting with a nonprofit debt counselor.

Been there and done that? OK. Brace yourself.

How much of a whack you’ll suffer depends on any number of considerations, some of which are nearly impossible to predict. This much is certain: Depending on which kind of bankruptcy you file — Chapter 7 (discharge debts) or Chapter 13 (reorganize debts; get on a payment plan) — you’re likely to see your score plummet between 160 and 240 points.

Ironically, credit scores that were lower pre-bankruptcy tend to lose fewer points than credit scores that were significantly higher. An eight-year-old FICO study showed someone with a 680 credit score losing 150 points, and someone with a 780 losing 240 points. The plunge puts both bankrupts in the same unattractive neighborhood of 530-540.

In short, consumers with better credit histories have more to lose; those with lower credit scores already have many of their financial problems baked into their histories.

Create a New Budget

Except for those driven to bankruptcy by unforeseen events or unavoidable catastrophes, the most likely culprit in financial disaster stories is the petitioner’s failure to stick by a realistic budget.

This is nothing new. The great English author, Charles Dickens,  described the razor’s edge between happiness and misery as overspending one’s income by mere pennies.

So, create a fresh budget. Arrange your post-bankruptcy expenses in three columns: fixed, variable, and irregular.

Fixed expenses include, for example, your housing payment, car payment (if any), and, if you’ve chosen Chapter 13, any regular payment to satisfy your reorganization.

Variable expenses are those that arise each month but tend to fluctuate: food, clothes, entertainment, fuel, utilities. This is an area to attack.

  • Examine at least 3-to-6 months of bank and credit card statements.
  • List down to the penny where your money has been going.
  • Identify areas of overspending. Do you really need premium cable and/or unlimited cellular data? Is that new dress/suit necessary? Are you buying premium gas for your car when it would run happily on mid-grade?

Irregular expenses aren’t part of each month’s spending, but do arise occasionally — sometimes predictably. Do you pay insurance quarterly, semiannually, or annually? Medical expenses often aren’t scheduled. Take a good look at what you spend on gifts for others. Again, review your bank and credit card statements with an eye to future trimmings.

Next, get a handle on your savings. With bankruptcy having cleaned your slate, or at least made it more manageable, you’re in the unfamiliar position of being in command of your finances. That’s the point of bankruptcy, says Judge McEwen, and it’s in everyone’s best interest if you seize the opportunity.

Without bankruptcy protections, she notes, we would have far fewer risk-taking entrepreneurs whose successes create jobs, build stable neighborhoods surrounding better schools turning out bright graduates eager to become the risk-taking entrepreneurs of the future.

“Without bankruptcy, we’d have fewer dreamers,” the judge says. “There would be zero second chances. Going broke would be a dead end. … Bankruptcy gives everyone a right to try and fail, and then get a second chance.”

Make the most of yours: Designate a set percentage of savings from every paycheck, and make it a priority. Your dad was right: Pay yourself first. Your target: at least 10% savings every payday. You may have to get there by cutting costs or adding income. Either way, get there.

A serious budget will be based on four weeks of take-home income. Yes, if you’re an employee, there will be some months when there’s an extra paycheck because of how paydays fall. If you’ve budgeted well, that extra paycheck can go straight into your emergency savings account.

In short, if you’re paid every two weeks, simply double whatever your net, after-tax, after-deductions household income is. That’s the amount of budgetable income.

A variety of well-tested budget plans exist, many of them based on a simple all-cash envelope-or-wallet method: Turn your spending income into currency, divide it into envelopes or wallets for designated purposes, and spend only what you have allotted on each expense. For the digitally savvy, there are online budgets or smartphone apps that accomplish the same task.

Make your savings automatic and inconvenient to get your hands on. Set up an account at a bank or establish a relationship with a credit union. Have a portion of your check direct-deposited into that account. Maintaining your savings account in a separate institution from your checking account will make transfers slightly more difficult, and that’s a good thing.

Ease Back into Credit

Do not count on qualifying for a typical unsecured credit card for a while. Still, you’ll want a credit card because good reports from the issuing company are among the fastest ways to improve your credit score after bankruptcy. So put a positive spin on your newfound financial reliability by applying for a secured credit card — that is, a card guaranteed by your cash deposit against failure to pay.

For example, if you want a card with a $500 spending limit, you must pony up $500 to the card company as a deposit guaranteeing your reliability.

Even with a deposit, however, many companies won’t issue you a card for a year or more after your bankruptcy is filed. Hang in there. They want you back, but only after a cooling-off period.

Beware Credit Card Fees; Use New Credit Wisely

Because you were once a bad risk, some companies attempt to charge stunningly high fees for secured cards, sometimes as high as $200 for a $500 card. Talk about adding insult to injury.

But we say “attempt,” because you have choices. Shop for a low- or zero-fee card, study the fine print, and make the choice best for you. Keep a sharp eye out for interest rates on balances carried over.

Also, make certain your new card company reports to all three credit monitoring agencies. Some don’t, and you’ll want the world to see how exceptionally well post-bankruptcy you is performing.

Once you’ve secured a secured credit card, you will demonstrate that excellent performance by using the card prudently, never going above 30% of the balance limit, and paying off the balance each month.

When you are comfortable paying off the secured credit card, you might be ready to try for an unsecured card. Once again, anticipate rejection, high fees, or punishing interest rates.

However, given sufficient time (typically one year) and diligence using your secured card — balances kept low and paid off each month — you should be able to obtain a regular, unsecured credit card — one even with rewards or cash back.

But the rules do not change: When you do get an unsecured credit card, keep the balances low and paid off — on time — monthly.

Building Credit with a Car Loan

The next step in rebuilding your credit score will be to obtain some sort of loan. Car loans are a good starting point, especially a short-term one with affordable payments. Managing the dual responsibility of vehicle and credit card payments will boost your credit score.

Capably managing your credit after bankruptcy could put you back above 700 — the good-risk range — in as few as four years. Again, this means minimizing your credit card balance utilization, paying off balances, and being punctual with any debt payments.

The timely repaying of other secured loans — loans that are protected with deposits or collateral — also can help rebuild your credit reputation.

Buying a Home after Bankruptcy

As noted above, a bankruptcy will linger on your credit report for up to 10 years. This, however, does not mean you cannot qualify for a mortgage for 10 years.

Mortgage lenders benefit from a significant piece of collateral: the housing stock behind the loan. Furthermore, if the borrower is able to put down a substantial down payment — 20% or more — underwriters can be confident they will not be stuck with an unmovable piece of real estate if the house must be repossessed.

Still, lenders want to be confident about the borrower’s ability to repay. Besides all the usual investigation into job and income stability, they’ll look hard at the applicant’s payment history.

After a bankruptcy, then, you’ll have to temper your new-house fever for, probably, at least a couple of years. Meanwhile, you will distinguish yourself as someone who makes timely payments on your secured credit card, and possibly your secured loan or car loan.

Also, the longer you can wait after bankruptcy, and the better you can rebuild your credit, the more likely you are to strike a better deal on your interest rate. A half-point difference on a 30-year fixed-rate loan could add up to nearly $100 a month, and tens of thousands of dollars over the life of the loan.

Once you’re in the market — again, after about two years — be sure to include government-insured loans in your shopping. These tend to be more forgiving of bad credit scores. Investigate FHA- or, if you’re looking in a rural community, USDA-backed loans. Veterans who’ve been two years with clean credit post-bankruptcy can access their VA benefits.

The Bottom Line

Bankruptcy will be considered a negative on your credit report, at least for 7 to 10 years. There is no way around that.

Bankruptcy does not erase a bad credit history, but it does give you a second chance. Don’t waste it. Demonstrate you’ve learned a lesson about personal finances, and your credit score will begin to reflect that.

Remember, you have a right to fail, and still come back strong. You can emerge from bankruptcy with all the financial rights and privileges you need to be successful.

About The Author

Bill Fay

Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].

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