The decision to go through a bankruptcy can affect the life of a consumer in the United States for years. In fact, most bankruptcy attorneys advise their clients to expect to see the effects of a bankruptcy on their credit report for up to seven years. Typically, most financial advisors tell their clients that their credit score could decrease by as much as 200 points if they file bankruptcy. But soon after filing, many people discover that their scores are actually higher than before than filed.
There are several reasons for this phenomenon. To start, many people who choose bankruptcy have struggled with their bills for months or years. Their credit reports are already full of late payments, charge-offs, and other dings. The average credit score of someone filing bankruptcy is typically in the low 500s, but it is not uncommon to see scores in the 400s and 300s among people filing for bankruptcy.
After filing bankruptcy, the credit report is wiped clean. All of the high loan balances are removed along with any late payments and records of unpaid debts. These accounts are marked as “Included in Chapter 7 Bankruptcy” or “Included in Chapter 13 Wage Earner Plan,” depending on the type of bankruptcy that is filed. The removal of this bad information from a credit report can often result in a consumer’s credit score actually going up.
A bankruptcy can also help a credit score over the long term. When the three credit bureaus are calculating credit scores, the formulas that are being used are designed to rate a consumer’s credit as compared to that of consumers in similar financial positions. To do this, the credit bureau divides all consumers into ten groups, then ranks the consumers in each group in relation to the others in the group. One of these groups is made up only of bankruptcy filers.
In short, someone who files bankruptcy is having their credit evaluated only against other bankruptcy filers. As a result, it is possible to have a high credit score in comparison with other bankruptcy filers, resulting in a high score. Of course a “penalty” will still be assigned to the score of someone who filed bankruptcy, but it is possible to have a score in the 700s. Someone who has filed for bankruptcy, but then manages to pay all of their bills on time and keeps a few lines of credit available for use can easily find themselves with a high credit score within a matter of months.