An urban legend has it that filing for bankruptcy renders you unable to borrow money for seven years, in much the way that breaking a mirror gives you seven years of bad luck. In this case, bad luck means pulling a wad of one-dollar bills and counting coins in the checkout line of the supermarket as you buy instant ramen noodles, government cheese, and store-brand margarine. The truth is that bankruptcy filings affect everyone’s credit score differently; it depends on your debts and your payment history before the bankruptcy filing, as well as which debts the court decides to discharge. The worst-case scenario is that filing for bankruptcy will tank your credit score, but that only happens with some bankruptcy filers. You might find that your credit score only gets a little bit lower after you file for bankruptcy, and some people’s credit scores even go up after a bankruptcy filing. Do not let your fear of lowering your credit score stop you from contacting a New Jersey bankruptcy attorney.
What Is a Credit Score?
Your Fair Isaac Company (FICO) credit score is named after the company that established the credit score formula for determining customers’ creditworthiness. It originally used it only in-house, one company assessing the risk of issuing credit to a limited pool of customers, but today, all three major nationwide consumer credit reporting companies (Equifax, Experian, and TransUnion) use this formula to assign a credit score to consumers, and prospective lenders rely on the credit reports issued by these companies to determine the risk of lending to these consumers. Your FICO credit score is based on five criteria, weighted in different proportions:
- Payment history – Credit reporting agencies look at the percentage of credit payments that you have made on time. The bad news is that certain bills do not count toward this score, even if you have never been late on a payment. Credit card payments and auto loan payments count, but rent, utilities, and buy now pay later (BNPL) payments do not, although this may change soon. Payment history accounts for 35% of your FICO credit score.
- Amounts owed – This is your outstanding balances on loans and lines of credit. In other words, it is your credit-to-debt ratio. Having a nearly maxed-out credit card plus an auto loan and a home mortgage means that you have less wiggle room in your budget than someone who is only obligated to make payments on one of those debts, meaning that your risk of default on any of those debts is higher. The amount owed accounts for 30% of your credit score.
- Length of credit history, including the age of each individual credit account, counts for 15% of your credit score.
- Credit mix – Having a variety of credit accounts works in your favor. From the perspective of the credit reporting agencies, having a credit card, a car loan, a home mortgage, a personal loan, and a home equity line of credit is better than having five credit cards. Just as you should diversify your investments, you should diversify your borrowing. Credit mix is 10% of your credit score.
- New credit counts for 10% of your credit score. When you open multiple new accounts in a short period of time, in other words, before you repay a substantial amount toward the earlier ones, this counts against your credit score.
What Happens to Your Credit When You File for Bankruptcy?
When you file for Chapter 7 bankruptcy, the court discharges most of your debts. This negatively affects your credit mix. How it affects your amounts owed depends on how your credit score was before you filed for bankruptcy. Chapter 7 bankruptcy lets you keep certain assets, such as your house and your car. Therefore, if you file for Chapter 7 bankruptcy, thereby discharging your credit card debt and unpayable medical bills, but you keep up with your mortgage and car loan payments, your credit score will begin to improve shortly after your bankruptcy filing.
After you file for bankruptcy, you can slowly begin to reopen credit accounts, but you must start small because most lenders do not want to lend to someone who has recently declared bankruptcy.
In my experience, a year after a Chapter 7 Bankruptcy filing, as long as you have remained current on your car payment, housing payment and other bills, the average credit score goes up into the high 600s. A year after bankruptcy is a great time to apply for a new credit card.
Two years post Chapter 7 Discharge, your credit should be pretty perfect again. My clients have been able to purchase homes two years post-discharge and can finance or lease a vehicle at a competitive interest rate two years after exiting bankruptcy.
With Chapter 13 Bankruptcy, after a year of on-time payments to the bankruptcy trustee, the same applies as with a Chapter 7 Bankruptcy.
Two years into a Chapter 13, clients have qualified for mortgage refinances or new mortgage loans while in bankruptcy. Clients are able to purchase or lease a vehicle while in Chapter 13.
Contact a New Jersey Bankruptcy Lawyer
Jonathan Goldsmith Cohen has helped thousands of clients successfully apply for Chapter 7 and Chapter 13 bankruptcy. If you think bankruptcy may be the right decision for you, contact our office right away to discuss your situation with an experienced bankruptcy lawyer.