Bankruptcy and Credit Effects: What You Should Know

Bankruptcy and Credit Effects: What You Should Know - Lexington Law Firm

When it comes to credit mistakes, not all are created equal. While the occasional late payment won’t ruin your credit score, filing for bankruptcy could lead to years of serious damage. If credit repair is a goal, consider the following before choosing bankruptcy. It may be a short-term solution, but the long-term consequences are substantial.

  • Effect #1: Asset liquidation or restructuring. There are two kinds of consumer bankruptcy: Chapter 7 and Chapter 13. When a person is unable to pay any of their debts, they may qualify for protection under Chapter 7. This type of bankruptcy enables the assigned trustee to liquidate a person’s assets in order to repay creditors. When a person can repay a portion of their debts, they may qualify for Chapter 13, allowing the trustee to restructure their debts into affordable payments. Either way, both parties are faced with severe and immediate lifestyle changes. Asset liquidation means home foreclosure, loss of some investment and savings account funds. Debt restructuring means adhering to a strict schedule and discretionary allowance. Both avenues lead to difficult and immediate change. Be aware of this reality before resigning yourself to bankruptcy court.


  • Effect #2: Significant credit damage. According to FICO, bankruptcy can cost you more than 250 credit score points depending on your current standing. For example, if Jeff has a credit score of 780 and files for Chapter 7 bankruptcy, his score could be reduced to 530. A Chapter 7 bankruptcy citation will remain on Jeff’s credit report for up to 10 years, forcing him to live with the consequences of a depressed score. Despite his cancelled debts, Jeff can no longer afford to live without a roommate, must take a second job to begin saving again and must change his lifestyle to avoid living with credit card debt. His damaged credit score has also damaged his reputation, an eventuality that will take years to repair.


  • Effect #3: Limited options. Speaking of consequences, limited options are at the top of the list. Bad credit means meager access to future financing including mortgages, consumer cards, auto loans, student loans and even apartment rentals. A low credit score will also raise your insurance premiums and the interest rates on existing accounts. To obtain new credit, you’ll probably need to secure a cosigner in the months following bankruptcy.


Sometimes bankruptcy is unavoidable, but it should never be “inevitable” in your mind. There are plenty of options before reaching the breaking point. Protect your credit by:

  • Speaking to lenders directly about your situation. They may offer a forbearance period or altered payment schedule to assist you with your financial troubles.
  • Securing a second or better paying job. Reducing debt and building savings are the cornerstones of financial stability.
  • Asking for help. Professional assistance is essential when credit repair is on the line. Don’t wait for things to get worse—be proactive and tackle your problems today.
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