Bankruptcy and Credit Scores

Your credit score is a quantitative measure of your financial history. Calculated by three major institutions who use slightly different techniques and scales, these scores are the single most important factor determining how much you can borrow and what interest rate you will pay. A bankruptcy is the most damaging event for your credit and will significantly drag down your score. It will also be reported for a full decade on your financial report cards.

Credit Score

Your credit score is basically your last seven to 10 years of financial history summed up in a single figure. These scores are calculated by three major credit reporting bureaus in the United States: Equifax, Experian and TransUnion. The scores are based on proprietary formulas, which take into account your income, outstanding debt, when these debts will be fully paid off, past delinquencies and defaults, as well as your unused credit lines. In addition, bankruptcy filings are factored in and have a very large impact on the final score. Ordinarily, the credit score is calculated based on the last seven years of data. Bankruptcy filings are an exception, however, and will continue to negatively impact your score for 10 years.

Impact

Although different rating agencies use slightly different scales, the figures are comparable. A score of 680 and above is usually considered satisfactory, also referred to as "prime". Scores between 575 and 680 are subprime and indicate that the funds extended to the borrower carry a significant repayment risk. The term "subprime mortgage" refers to mortgage loans extended to these types of borrowers. Loan applicants with scores below 575 will be usually denied credit unless they find a cosigner with better credit history. A bankruptcy filing will usually drag your score down by 160 to 220 points. The more recent the filing, the greater the impact. The quantitative hit on your record, however, will continue for the full 10 years.

Credit Report

In addition to producing a final number, in the form of credit scores, the rating bureaus also produce credit reports. These reports include the specific information used to calculate your score and outline specific events such as bankruptcies and defaults, along with the exact dates, size of the default and so on. The bankruptcy will be prominently mentioned on this report for 10 years after which it will no longer be reported. Naturally, a bankruptcy will make it very hard, and in many cases impossible, to obtain home or car loans, mortgages or credit cards. Usually, only after a few years have passed and you have demonstrated the ability to handle your finances more responsibly will lenders start to provide small loans again.

Recovery

It is, of course, best to avoid bankruptcy filings if at all possible. If, however, you have no other choice, try to work with a bankruptcy lawyer who can ensure that you can make a fresh start as quickly as possible. The more accurate the paperwork and the more comprehensive the plan presented to the judge in bankruptcy court, the faster you can start to rebuild your credit. You are likely to be denied all credit applications at first. Don't despair. Get either a prepaid credit card or find a cosigner. In either case the limit on the credit card will be very low, but a small step toward building a clean credit history is far better than not acting at all.