5 Ways That Bankruptcy Can Actually Improve Your Credit Scores
By Tracy L. Hirsch
You’ve most likely only heard negative things about filing for bankruptcy. I’ll show you the positive ways that it can help you build a better financial future.
If you’re in over your head in credit card debt, medical bills, and car payments, you’re not alone. The average American has approximately $38,000 in personal debt (not including home mortgages), and that number is steadily rising.
This usually comes with high APRs and large minimum monthly payments, which leaves little to no money for your basic needs, such as rent, groceries, and insurance premiums.
In spite of the myths, there are upsides to filing for bankruptcy in Kentucky (or any state for that matter) if you have creditors coming after you for unpaid bills. While it’s true that a bankruptcy petition will lower your credit scores initially, it can actually benefit your scores (directly and indirectly) in the long run after your bankruptcy plan is completed.
Here’s how bankruptcy makes that a possibility:
1.) It stops negative reporting on your credit report.
Every single time you miss a payment, make a late payment, or pay less than the minimum due on your bills, your creditors report it negatively. This greatly decreases all three of your credit scores (Experian, Transunion, and Equifax) as it shows that you are not repaying your debt in accordance with the borrowing terms.
When you file for bankruptcy, however, your bankruptcy plan prohibits creditors from reporting delinquencies to your credit report.
Since your creditors can no longer report late or missed payments (which again, decreases your scores), your scores will start to improve after your bankruptcy discharge based on the absence of those negative reports.
While your scores will initially drop when a bankruptcy is reported, it can be the impetus for better scores in the long term since your credit scores were taking a major hit with each negative report.
In spite of the myths and social stigmas, bankruptcy can actually help you improve your financial situation, including your credit scores.
2.) It improves your credit utilization ratio.
Since you’ll no longer owe the debts that were on your report (because they are discharged in bankruptcy), this greatly improves your credit utilization ratio.
Your utilization ratio is a percentage that reflects the amount of credit you use compared to the total amount of credit available to you. For example, if you have a $1,000 credit limit on your Visa card, and your balance is $200, your utilization ratio is 1/5th or 20%.
Ideally, that percentage shouldn’t ever be over 30%, but in many cases, credit cards are maxed out to the upper limit, which puts the utilization at 100%.
When you file for bankruptcy and your debts are discharged completely (Chapter 7) or paid through a repayment plan (Chapter 13), those debts are removed from your credit report. Once they’re removed, your utilization on all lines of credit (that are part of your bankruptcy plan) will go down to 0%.
This gives you the opportunity to use those cards to your benefit after your bankruptcy plan is completed. If you use those cards to charge small purchases (gas, groceries, etc.), and then pay them off in full and on time each month, this will get you on a path to rebuilding your credit to improve your scores.
3.) It allows negotiation to lower your APRs.
When you have lower APRs (Annual Percentage Rates) on secured debts, such as car loans, you have more money to pay off your debt in a Chapter 13 bankruptcy repayment plan.
Your bankruptcy attorney will work on your behalf to negotiation new terms on your loans in a Chapter 13, which could save you hundred or even thousands of dollars in interest. Some repayment plans only require a small percentage of repayment on credit cards and other unsecured debts.
This means that your monthly payment in your bankruptcy repayment plan will be lower, which in turn, allows you to save money for necessities as they arise and even complete a bankruptcy plan early (when possible).
While this is an indirect affect, in the case of a 100% repayment plan, if you are able to save money and pay more towards your Chapter 13 repayment plan, you can complete a Chapter 13 ahead of schedule, and can start rebuilding your credit and improving your credit scores much sooner.
4.) It blocks creditors from taking money out of your bank account.
If your wages are being garnished, you may be losing up to 25% of every paycheck, which gives you even less money to pay your monthly bills.
When you file for bankruptcy, it invokes what’s called an “Automatic Stay.” This basically means that you are legally protected from creditors, and they aren’t allowed to take money from your bank account or garnish your wages.
This is one of the greatest benefits of bankruptcy, as it has a domino effect. Protecting your paychecks means that you have more money to pay back your creditors in a Kentucky Chapter 13 plan, which in turn (as seen in point #3), allows you to complete your plan faster if you’re in a 100% plan.
This again puts you on an expedited track to rebuilding your credit history and helping to increase your scores.
5.) It provides a post-bankruptcy budget.
Once you get a successful discharge from your bankruptcy plan — which now gives you breathing room to pay your current monthly bills on time every month — this plays a huge role in helping you start to increase your credit scores.
It also improves your debt-to-income ratio, which is important to know when you’re ready to purchase a home or car. Planning for those purchases help you avoid getting into another situation where you have too much debt that you can no longer pay.
All this to be said, it’s true that your credit scores will initially drop when you file for bankruptcy. If you file a Chapter 7, it stays on your credit report for ten years, and if you file a Chapter 13, it stays on your credit report for seven years. However, while your scores do initially drop, they then slowly start to increase (once your plan is complete) due to all of the factors listed above.
In the long run, your credit score would end up being extremely low if you went 5, 7, or 10 years without filing for bankruptcy, as the interest alone would keep you from being able to make the minimum payments. As a result, your creditors would end up filing judgment liens against you, which would put you in an even worse position (entailing home foreclosure and car repossession).
When you have a budget in place and know how to properly manage your finances and make payments on time, your credit scores will increase after your plan is over, and any new creditors will see that you are capable of paying back loans.
Want to learn more about how bankruptcy can help your particular situation? Call or text me at (502) 435-2593 to set up a free consultation. If you already have creditors coming after you, now is the time to find out if a southern Indiana or Louisville bankruptcy filing can help protect you!
All the best,
Tracy L. Hirsch
Louisville KY Bankruptcy Lawyer
Not ready to call? You can text me a question at (502) 435-2593, and I’ll personally text you back!