One of the most common questions we get from clients is this: “How will this affect my credit?” The common myth is that a bankruptcy will ruin your ability to obtain credit in the future. While the filing of a bankruptcy will have a negative effect on credit scores, many of our clients find themselves pleasantly surprised at how quickly they bounce back. They’re also often surprised at how bankruptcy helped them get their finances back in order. The bottom line is that bankruptcy was designed to help people.

In the most cases, the credit score of someone considering bankruptcy has already taken a hit from the debt obligations which they have been unable to pay (payday loans, personal loans, vehicle payments, mortgage, medical bills, credit cards, etc.). As a result, some, most, or even all of their creditors have started reporting negatively on their credit report. The result of which is a damaged credit score.

Falling behind on these obligations will cause a credit score to take a hit, however most of my clients find that the filing of a bankruptcy stops the bleeding.  Once the bankruptcy is filed, your creditors are no longer able to report to the credit bureaus. This means, that the negative reporting ceases immediately, on a go-forward basis.

The exact formulas used to calculate an individual’s credit score are a closely guarded secret. To make it more confusing, each credit bureau can have their own credit scores. A common credit score used by many lenders is called a FICO score– however there are tons of sub categories of FICO scores! Did you know there’s a “FICO Score 8” or a “FICO Score Auto 5”?

Despite there being a lot of factors that go into a calculating a credit score, there is one thing that is a major factor for lenders. This factor is called your “debt to income ratio.” This value represents, and somewhat predicts, an individual’s ability to repay a loan.  If you have a mountain of outstanding debts, you could still be an attractive borrower.  If you have low income, but no debts, you also could be an attractive borrower. The issues happen when the debts you owe are compared and weighed against to your income.

Let’s take a millionaire with a regular stream of income, for example. This person seems like an attractive borrower income wise. I mean, they’ve got millions! Surely they can pay their debt back!  Then after pulling a credit report, it turns out they have a billion dollars worth of unpaid debts. Suddenly, this borrower is not someone the bank wants to lend money to because of all the other debt that needs to be repaid.

With bankruptcy old, outstanding debts are usually forgiven upon receipt of the Order of Discharge. Since most, if not all, the debts are gone, your “debt to income ratio” will flip around.

Many of our clients are shocked when they begin to receive credit card and vehicle offers soon after discharging their bankruptcy. This is typical, and is a result of the credit industry viewing you as a good bet. After all, you have just completed a credit counseling course, a financial management course, and are not eligible for another bankruptcy discharge for eight (8) years. Typically your credit score after bankruptcy will be better within a few years. With some hard work, it can be even better than before the bankruptcy.

A word of caution: The first few waves of offers often come with very high interest rates. Eventually, the rates will go down over time. Especially if you work diligently to improve your credit.