It’s formally known as legal protection from your creditors, but everyone just calls it “bankruptcy.” If you’re overwhelmed with debt and there’s no chance you’ll ever be able to pay it off, then bankruptcy is an option you’ll likely explore, although it should probably be your last resort. Bankruptcy filings will find their way to your credit reports, and they can stick around for a very long time.
The Fair Credit Reporting Act (FCRA) allows the three national credit reporting companies (CRCs—Equifax, Experian and TransUnion) to preserve records of bankruptcy for up to 10 years. And, as you no doubt assume, bankruptcies are not positive credit report entries. In fact, your credit scores can never be as high as they could be so long as a bankruptcy filing is listed on your credit report.
The decision to file for bankruptcy isn’t an easy one. In addition to the lasting negative impact on your credit scores, bankruptcy is an expensive process. Balancing its high costs against the opportunity to wipe the slate clean and become debt-free is a challenge one million U.S. consumers must deal with every year.
The good news about bankruptcy, besides the fact that it can render an individual overwhelmed by unpaid bills essentially debt-free, is that as time passes after the bankruptcy filing (or, as credit-scoring pros say, as the record ages), its negative influence on your credit scores will diminish.
That means that even if you do nothing to rebuild your credit in the years following the filing, your scores will improve organically over time, assuming you’re not re-polluting your credit reports with new derogatory information. You can, and should, take more proactive action to improve your score as well; the steps are much the same as for newcomers to the credit world, seeking to obtain a credit score for the first time.
Note, however, that even as your credit scores begin to increase, you may have difficulty obtaining credit approvals, especially in the first few years following a bankruptcy filing.
Debts eliminated by bankruptcy cannot remain on credit reports longer than seven years from the date the individual accounts began going into default. And, if you have third-party collections on your credit reports, each must be removed within seven years from the date the original account went into default. That means the record of your bankruptcy filing will likely persist on your credit reports longer than the defaulted debts eliminated by your bankruptcy.
Some lenders make a policy of denying credit to any applicant with a bankruptcy on his or her credit report—even one with a credit score that exceeds the lender’s minimum requirements. And some lenders will never lend you another dime if you’ve discharged a debt with them in a bankruptcy, regardless of how much time passes, or how high your credit scores may climb.
It’s also important to keep in mind that not all debts can be erased via bankruptcy. In legal lingo, these debts are not statutorily dischargeable. These include tax liens and government-guaranteed student loans. Your bankruptcy attorney should explain how this limitation might apply to you and set realistic expectations.
This brings us back to that other downside to filing bankruptcy: It can be expensive. You’ll want to hire an experienced bankruptcy attorney to help with the filing. Their fees can be well over $1,000. Various additional fees could total another $400. And no, those expenses cannot be discharged in the course of the bankruptcy. These are steep expenses to anyone who’s having difficulty paying their bills. Nevertheless, if it allows you to eliminate most or all of your debt and get a fresh start, the costs may be worth it.