This is perhaps the most common myth. Most people make filing for bankruptcy a last resort due to fear that their credit will be destroyed. Fortunately, this is not true. Bankruptcy will most often improve your credit over the long run by removing debt obstacles and balancing your budget.
- Chapter 13 and your credit: Chapter 13 is a reorganization and repayment program. The program is designed to consolidate bills, reduce debt and create a balanced budget while improving your credit. How does it work? According to FICO, 65% of your credit is comprised of two factors:
- Your payment history (35% of score) – timely, consistent payments to your creditors; this has the biggest impact on your credit score.
- Your debt load or leverage (30% of score) – how much debt do you have relative to your income or ability to repay.
So how does the Chapter 13 program work to improve your credit?
- The program re-establishes timely monthly payments to your creditors and stops the “late” reports to the credit reporting agencies therefore improving your payment history, which accounts for 35% of your credit score.
- Chapter 13 focuses on paying down principal debt. All unsecured debts, second mortgages and mortgage arrearages are paid back at 0% interest. So all payments go straight to pay down the bottom line principal debt, therefore reducing debt-to-income ratio each month of the program – a factor that influences 30% of your credit score.
Chapter 7 and your credit: Chapter 7 is a debt elimination program that allows you to eliminate all unsecured debts (such a credit cards, medical bill, personal loans, etc) and make a fresh financial start. It is also a clean slate for your credit. Remember when you got your first loan or credit card and began establishing your credit? This process is simply repeated after a Chapter 7 bankruptcy. After a Chapter 7 discharge, we recommend that our clients establish and maintain manageable credit sources. This begins the process of establishing positive credit history and will begin building and improving your credit score.