Personal Bankruptcy and Your Credit

The Truth About Bankruptcy and Your Credit

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Bankruptcy is not something you want to have on your permanent credit record. Although more than 2 million Americans go bankrupt every year, the majority of them do not take official steps to file for bankruptcy in the eyes of the government.

When you declare bankruptcy, you are taking an official legal action — essentially saying, "I cannot repay all of my outstanding debts and want to make a fresh start." Unfortunately, a Chapter 13 bankruptcy filing will remain on your credit record for at least seven years, and Chapter 7 bankruptcy filings can stay there for 10 years. Either of these bankruptcy filing can affect both your credit score and how lenders perceive your credit worthiness.

The most common personal bankruptcies are either Chapter 13 (known as "reorganization") or Chapter 7 (known as "liquidation"). Most people have heard of Chapter 11 bankruptcies, but this type of bankruptcy is reserved for corporations.

If you file Chapter 13, you may be able to keep your home and any stocks you have. You are expected to work off a reduced debt by paying a percentage of whatever wages you earn. Usually, a court pre-determines a specified dollar amount, based on your regular salary, or claims a percentage of whatever income you can generate after you have filed.1

If you file Chapter 7, though, your properties are actually sold off to pay creditors. However, certain properties are deemed exempt and are therefore not eligible for sell-off. These exemptions, like overall bankruptcy laws, vary from state to state.2

To protect your credit, explore every other option before filing for bankruptcy

From a credit perspective, you want to make every effort to avoid bankruptcy. As noted, a bankruptcy filing can stay on your credit report for up to a decade, and potential employers and lending institutions are sure to discover it when they run a credit check. To avoid any surprises, it's a good idea to keep your credit under control by closely watching it with the Privacy Matters 1-2-3 credit monitoring program

Additionally, experts say that officially declaring bankruptcy can lower your credit score more than 200 points. That can be a tough setback to overcome, and you should consider all other possible options.

Not only is bankruptcy harmful to your overall credit history, it's also become a lot harder for you to declare bankruptcy in general.

New U.S. bankruptcy law was enacted in 2005

In April 2005, the bankruptcy laws in the U.S. were officially revised with the signing of the Bankruptcy Abuse Prevention and Consumer Protection Act. This legislation amended the Bankruptcy Code of the United States.

Here's an at-a-glance view of some of the policies under the new law:3

  • In order to file an official bankruptcy claim, the law now requires you to get official credit counseling first.
  • If you have a "higher income" (usually recognized as above the median U.S. income of $46,326), you won't be able to apply for Chapter 7 bankruptcy. Instead, you can repay some of your debts under Chapter 13.
  • The means test was designed to figure out how much disposable income you have — to see if you can file for a Chapter 13 bankruptcy. If the dollar amount you end up with after deducting certain allowed expenses and debt payments from your monthly income is lower than that median income number, you may be able to file for Chapter 7 bankruptcy.

Declaring bankruptcy is a drastic step that no one wants to take. However, if you've exhausted all other options and are considering filing for bankruptcy, you should begin the process by taking a look at your credit report. Viewing your credit report will let you see your official credit history, including your outstanding debt, as recorded by one or all of the three major credit bureaus.

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