Bankruptcy Effect on Credit: It’s Often Better than Debt Settlement Schemes
The bankruptcy effect on credit is not always negative. Contrary to what the debt settlement industry will tell you, filing for bankruptcy protection can in certain situations actually improve your credit. Entering into a costly debt consolidation program on the other hand will inevitably harm your credit in the near term if you were current with your payments going in. That’s because the first thing a debt settlement company will tell you is to stop paying your credit cards and other lenders. They will instruct you instead to start making hefty monthly payments to them, while they eventually may get around to trying to work something out with your creditors one at a time, often without success. Your creditors then inform all three credit reporting agencies that you are seriously delinquent with your payments. That’s very bad for your credit for a very long time, and often just as negative as any damage caused by filing for bankruptcy protection.
If you are already in default making payments to your credit cards and other unpaid loans before seeking bankruptcy protection, then once those debts are discharged through Chapter 7 or Chapter 13 bankruptcy, they will be reported as discharged, not seriously delinquent or in default. That’s often better for your credit score. I have heard from hundreds of clients over the years that within a short time after receiving their bankruptcy discharge, their credit scores actually improved!
Filing Bankruptcy Can Actually Help You Start Rebuilding Your Credit
Filing for Chapter 7 or Chapter 13 bankruptcy protection provides an orderly process of debt relief through partial payment or a full discharge of most consumer debts. And unlike private debt settlement, your creditors must observe the protection from collections that bankruptcy provides. Chapter 7 bankruptcy is a short process, providing a fresh start financially within just three months usually. After your Chapter 7 case closes, you are free to begin rebuilding your credit right away. While there may be some lingering bankruptcy effect on credit, that does not mean that one cannot start rebuilding her credit immediately after bankruptcy. There are many strategies for rebuilding credit after a bankruptcy discharge, including:
- Applying for a secured credit card. These cards are widely available to consumers who have recently received a discharge of their debts in bankruptcy. They are offered by banks and some credit unions. You put down a small security deposit, often as low as $500. This amount is usually also the credit limit on the card. Use it monthly, and pay it on time every month, and the positive payment history will help rebuild your credit score.
- Buying a car. I never advise a client who has recently had her debts discharged to run right out and buy a brand new car. Instead, let someone else suffer the first three years of depreciation, and finance a certified used car around 3-4 years old. These days, cars are made to last much longer than in the past, and a smaller loan with manageable monthly payments will help rebuild your credit after bankruptcy quickly. Whatever you do, however, shop around for the best interest rate. Beware used car lots with banners about “bad credit” being OK! These days, “sub-prime” auto loans at upwards of 22% have become a major problem!
Making Monthly Chapter 13 Payments Can Help Too
As FHA, Fannie Mae, and Freddie Mac have begun to back more home loans over the last year or so, underwriters have begun to take Chapter 13 payment histories into account when making lending decisions. We know this from San Jose mortgage brokers who work with our Chapter 13 bankruptcy clients to purchase a home or refinance their existing mortgage loan. Twelve months of timely payments to the San Jose Chapter 13 trustee can often be enough for approval for an FHA mortgage loan.
