Bankruptcy Can Actually Improve Your Credit Score
Bankruptcy is often associated with financial ruin and a damaged credit score. However, there is a surprising silver lining to this process that many people overlook or do not know about. While bankruptcy might have a negative impact on your credit in the short term, it can also pave the way for a brighter financial future and potentially lead to an improved credit score in the long run. For a lot of people, especially those who have missed payments, bankruptcy can improve credit scores; as a result, many people who filed bankruptcy are shocked to see their credit after bankruptcy.
Many people worry that bankruptcy will ruin or crash their credit score. This is far from the truth. This horrible myth that bankruptcy will ruin your credit is one of the main reasons many people won’t consider the bankruptcy process. But, actually it can be a great stepping stone toward a strong credit score. Bankruptcy usually brings someone’s credit score to between 600 and 650 (depending on your own factors and what chapter you file). This means that whether you start at a 350 or a 800 credit score, it will end up in the same general area. For many individuals with substantial debt or missed payments, bankruptcy actually improves their credit score.
A Fresh Start
Bankruptcy is a legal process that allows individuals or businesses to eliminate or repay their debts under court protection. Chapter 7 and Chapter 13 bankruptcy are the most common types for individuals. When you file for bankruptcy, it’s like hitting the reset button on your financial life. It wipes out or restructures your debts, providing you with a fresh start and a clean slate to rebuild your financial future.
Not only does bankruptcy wipe away your debt but is also cleans up the credit report. Bankruptcy actually has a positive impact on a lot of the factors that make up your credit score. After bankruptcy you no longer have missed payments being reported each month, which helps your credit. Also, you have no debt/no outstanding balances after bankruptcy, which means you can control your new reported credit utilization, which can also help your credit.
One of the primary benefits of bankruptcy is the discharge of unsecured debts, such as credit card balances, medical bills, and personal loans. This debt elimination can free you from the overwhelming burden of unpaid bills, collection calls, and the constant stress of living paycheck to paycheck. As a result, you can start to manage your finances more effectively. Zeroing out all these debts substantially improve credit scores.
Improved Debt-to-Income Ratio
Your credit score is influenced by various factors, but that is only one factor for major purchases. When applying for loans, including mortgages and car loans, banks look at other factors besides just credit score; one of the most critical is your debt-to-income ratio. This ratio measures the percentage of your income that goes toward repaying debt. By eliminating or reducing your debts through bankruptcy, your debt-to-income ratio can improve significantly. Lenders often view a lower debt-to-income ratio as a positive sign of financial stability.
After bankruptcy, you can start rebuilding your credit. While the bankruptcy itself will remain on your credit report for several years, you can begin establishing a positive credit history through responsible financial behavior. The bankruptcy also impacts your credit score less and less as time passes. Secured credit cards, small personal loans, and timely bill payments can all contribute to the gradual rebuilding of your credit.
Most importantly every on-time payment post-bankruptcy is steadily moving your credit higher and higher. Prior to bankruptcy, for many, your on-time payments help very little since they might be counteracted by missed payments, late payments, or a high credit utilization. Post-discharge, most people have a credit score of between 600 and 650 with little to no work. If you put in the work, you just see even more improvement.
Credit After Bankruptcy Automatically Increases Over Time
As mentioned earlier, bankruptcy remains on your credit report for a set number of years (typically seven to ten years). During this time, your credit score may not be perfect, but it will gradually improve as the negative impact of the bankruptcy diminishes. Many people find that their credit score begins to increase shortly after the bankruptcy discharge. For most people, even if you do little to no work on your credit, you will steadily see improvement as time passes. But if you take some positive steps toward improving your credit, it will improve even quicker. Credit is like a muscle, you need to work it to get it and then maintain it.
One of the significant advantages of how bankruptcy can improve your credit score is the potential to qualify for a mortgage. Buying a home is a dream for many, and having a good credit score is a crucial factor in securing a mortgage with favorable terms. While bankruptcy may temporarily lower your credit score (in some circumstances), it provides a unique opportunity to rebuild your financial health. As your credit score gradually improves after bankruptcy, you’ll become a more attractive candidate for mortgage lenders. Some mortgage lenders have even sent potential buyers to file bankruptcy to clean up their credit faster than trying to payoff debt/settle debt or remove items.
By demonstrating responsible financial behavior, such as timely payments and prudent use of credit, you can position yourself to qualify for a mortgage and take significant steps towards homeownership. This is a clear example of how bankruptcy can serve as a pathway to achieving long-term financial goals, including the purchase of a home.
Qualifying for a Mortgage Post-Bankruptcy
The timeline for mortgage eligibility post-bankruptcy can vary depending on the type of bankruptcy you filed. In the case of a Chapter 7 bankruptcy, you may typically have to wait at least two years after discharge to qualify for a mortgage. However, it’s important to note that some lenders may consider applicants as soon as one year post-discharge, in very unique situations.
For those who file Chapter 13 bankruptcy, which involves a repayment plan, the waiting period might be shorter. Often, you can be eligible for a mortgage as little as one year after successfully adhering to your Chapter 13 repayment plan and obtaining court approval. Keep in mind that individual lenders may have different requirements, so it’s essential to shop around and find one that suits your specific circumstances.
Regarding credit scores, most traditional mortgage lenders prefer applicants to have a credit score of at least 620 or higher. However, if your credit score falls below this threshold, you can still explore options with lenders specializing in loans for individuals with lower credit scores. A higher credit score not only increases your chances of mortgage approval but can also lead to more favorable interest rates and terms. But, usually your credit after bankruptcy is at least 600, which means you do not have to do too much work to even get close to qualifying credit. The more effort you in, the higher you can see your credit increase.
Moving Forward Using Bankruptcy to Improve Your Credit
While bankruptcy may not be the ideal solution for everyone, it’s crucial to understand that it can have a positive impact on your credit score over time. By providing a fresh start, eliminating debt, and teaching financial responsibility, bankruptcy can be a stepping stone to a brighter financial future. If you find yourself overwhelmed by debt and struggling to make ends meet, consult with a financial advisor or attorney to explore your options and determine if bankruptcy is the right path for you. Remember, there is hope for credit score improvement even after experiencing financial hardship.
If you have a credit score of under 580, usually filing bankruptcy improves your credit score. Most people post-bankruptcy see a 600 or a 630 as a mediocre score, it is not a bad starting point. Similarly, it can also be easier to rebuild without missed payments, maxed out credit cards, high balances, or collections weighing your score down.
Finding help filing bankruptcy and improving your credit score
If you are dealing with improving your credit and eliminating debt, make sure you understand all your options. Ashley F. Morgan Law, PC helps many individuals manage their debts and their credit score every month. Attorney Ashley Morgan understands good credit is important and works to get her clients set up on the right path after bankruptcy. She provides guidance on improving credit after bankruptcy; and her credit cheat sheet and review is included as part of her bankruptcy packages to her clients.