How Does Chapter 7 Bankruptcy Affect My Credit Score?
This a question I get occasionally from a loan applicant, generally one that has filed a Chapter 7 Bankruptcy either recently or within the last couple years.
I start by explaining how a credit score is determined, and I use the Fair-Isaac Corporation (FICO) Credit Score as an example. The credit score is based on these factors: 35% is payment history, 30% is utilization/outstanding debt, 15% is credit history, 10% is credit inquiries, and the final 10% is the type of credit used. FICO quotes that 40% of the population has a score of 690 or below, with 40% scoring 745 or higher, with the final 20% being above 780 (the FICO range is a low of 300 with a high of 850.) There are other factors lenders use to determine if someone is a good credit risk, such as education, length of time in residence and current job, etc.
Now that they understand how a credit score is determined, I answer the 'How Does Chapter 7 Bankruptcy Affect My Credit Score' question. Obviously bankruptcy will affect their credit score, but there is good news and bad news. The bad news is: the score will likely be pretty low due to payment history not being so great, or maybe some (if not all) of the credit cards were maxed out, etc. The GOOD news is: after a person files bankruptcy, their credit is compared only with others who have filed bankruptcy!
I explain to them what an exciting opportunity they have in front of them, and it may be easier than they think to raise their credit score. I advise they sign-up for one of the outrageous interest rate credit cards they've gotten in the mail, charge a little, pay it off. Then repeat the cycle in two months. Pretty soon better card offers will arrive in their mailbox. After six months, come back to me, I'll re-run the credit report and we'll re-start the loan application process.
A recent bankruptcy does not have to be the end for potential home buyers. If they're willing to methodically work on the score, and check back in six months, chances are they'll hear GOOD news!
Photographer: Francesco Marino - FreeDigitalPhotos