The question of how filing for Chapter 7 or Chapter 13 bankruptcy will affect one’s credit score is possibly the most common question potential filers pose to bankruptcy attorneys.
Possibly, this question is posited even more frequently than the question of whether or not a bankruptcy filing can stop a foreclosure, garnishment, or eviction.
It is difficult to imagine that people considering filing for Chapter 7 or Chapter 13 bankruptcy might be more concerned with this manufactured number than with the question of whether or not they will be able to retain the home that they live in—but they do.
What Is a Credit Score?
First, what is a credit score, and why do people care so much about it?
The first question is easy to answer. The second question may require a degree in psychology for a response.
As to the first, the so-called credit score is simply the end-result of a confidential, proprietary mathematical formula developed by a private entity called the Fair Isaac Corporation (thus “FICO”).
The goal of the Fair Isaac Corporation is the same as Microsoft’s or that of the Coca Cola Corporation: to generate a profit.
Fair Isaac’s product is not a computer program or a bottle of soda pop, however: it is the sale of the FICO formula and end-results to other companies to assist them in determining whether or not to extend credit or financing to individual consumers (that’s you and me!) at the time and on the date that they apply for it.
Fair Isaac’s claim is that their formula allows businesses to make better lending decisions due to the accuracy of their formula (which is, again, proprietary—meaning that its actual mathematical contents are not disclosed to the public) and the end-result score.
The “FICO” score is not a persistent barometer of your moral worthiness. It is not even demonstrably accurate in terms of its specific purpose.
It is simply a number that is higher or lower depending on a variety of circumstances, be they factually accurate or in accurate, which credit reporting companies (again: private corporations with a profit motive) and other businesses review when you ask them to lend you money.
It means nothing until you fill out an application for a loan.
Even then, it only has meaning at that point because the lender has (very likely) decided to base its decision to extend credit to you on that essentially arbitrary number.
Nevertheless, people obsess over their credit scores. They download apps on their phones so that they can check it on a second-by-second basis. They pay money to the Fair Isaac Corporation, essentially, for the pleasure of doing this, when it already makes plenty of money from banks and other lenders.
This is the result of successful marketing by Fair Isaac. They have indoctrinated the American public into believing that the FICO score is in some way intertwined with the notion of self-worth.
This is nonsense.
Nevertheless, it is something that they want to know when considering Chapter 7 or Chapter 13 bankruptcy.
BANKRUPTCY AND YOUR CREDIT SCORE
It is well-known that, when you file for Chapter 7 or Chapter 13 bankruptcy, the filing is reported to the credit bureaus.
This happens electronically, at all hours of the day (bankruptcy attorneys often burn the midnight oil for their clients), on approximately a quarter hour-by-quarter hour basis.
The detrimental effect upon your credit score due to the bankruptcy reporting in the “Public Records” section of your credit reports is highly exaggerated.
First, if you are considering filing for bankruptcy, it is likely that your credit score has already been negatively impacted by late payments, missed payments, repossessions, evictions, foreclosures, and collections referrals.
While this is not the case with every potential bankruptcy filer, it is often the case.
The filing of a Chapter 7 or Chapter 13 bankruptcy, on the other hand, will immediately require the following with regard to credit and collections:
Immediate cessation of any and all collections activity by your creditors;
Cessation of any negative credit reporting by your creditors;
Cessation of past due or outstanding balances reporting by your creditors;
Zeroing out of all balances owed on your credit reports.
Yes, filing for bankruptcy will, in the short-term, cause your credit score to sink a couple of points.
No, it is not the end of your financial existence.
It is important to understand that, although the credit score formula is proprietary and held in confidence by Fair Isaac, it largely revolves around 2 numbers: (1) your debt-to-income ratio; and (2) the amount of “available credit” reflected on your credit reports.
When you file Chapter 7 or Chapter 13 bankruptcy, any open lines of credit that are not maxed out will in all likelihood by closed by your lenders. This reduces the amount of available credit that you have to zero.
However, the bankruptcy discharge is highly beneficial to your debt-to-income ratio, unless you have no reported revolving credit or medical debt (i.e., only non-dischargeable student loans, etc.).
The filing of a bankruptcy, followed by a successful discharge of your debt in the bankruptcy proceeding, will erase your negative credit history and allow you the opportunity to reboot and rebuild new, positive credit from the date of the bankruptcy’s filing onward.
Unless the reason you are filing the bankruptcy is for a unique reason unrelated to consumer revolving credit or medical debt, such as a mortgage foreclosure, the up-tick you see in your credit score when you discharge and flush all of that negative, historical debt from your credit report will more than compensate for the slight initial dip in your score.
BANKRUPTCY AND YOUR CO-SIGNER’S CREDIT SCORE
All of the above is true with regard to you, the filer of the bankruptcy, and possibly your spouse, who may file the bankruptcy jointly with you.
What about non-filing co-signers and co-borrowers? How does your bankruptcy filing affect their credit scores?
In general, the answer is: generally, it doesn’t.
Since the late 1990s, under consumer and regulatory pressure, the credit industry implemented a new reporting system for bankruptcy filings.
Where, prior to that time, anyone attached to an account implicated in a Chapter 7 or Chapter 13 bankruptcy would indeed have the bankruptcy filing annotated to their credit reports.
Since that change, a bankruptcy is now reported to the credit bureaus with regard to the specific individual filing the bankruptcy as identified by a single Social Security Number (or two, if it is a case filed jointly by a married couple).
A non-marital, non-jointly filed bankruptcy case should not in most cases be reported to the credit report of your Aunt Sally who co-signed for your credit card 3 years ago. Aunt Sally has her own Social Security Number, and she did not herself file the bankruptcy.
However, some few creditors still utilize the old reporting system. In this case, mistakes can yet happen.
Likewise, if the account is delinquent or becomes delinquent, a creditor is entitled to report it as such regardless of whether or not any account-holder has filed for bankruptcy or not.
MITIGATING THE EFFECT OF A BANKRUPTCY FILING UPON A CO-SIGNER’S CREDIT
The reality of the effect of a bankruptcy filing must thus be dealt with prior to filing a Chapter 7 or Chapter 13 when you have a co-signer on your conscience.
You are filing a bankruptcy because you cannot pay your debt (or, at least, in full). You care about the people who co-signed for you when you needed some assistance.
Yet, if you file the bankruptcy and proceed to discharge and leave unpaid the co-signed debt, your co-signer will indeed suffer the collections efforts of the creditor.
If you file Chapter 7, this will happen right away. If you file Chapter 13, it will happen 3-5 years later—unless you fully repay the debt through the Chapter 13, which may or may not happen with your particular Chapter 13 payment plan.
However, again, in a Chapter 13 bankruptcy, your co-debtor will be protected from collections harassment for the full 3-5 term of the process.
At the end of the day, it will not be your bankruptcy attorney’s job to assist your co-debtors.
Attorneys are retained by single (or married, joint) clients to aggressively represent that client and that client alone. In fact, attorneys are ethically obligated to behave in this manner. You are on your own in your concern for the co-debtor in question, although attorneys are always cognizant of a client’s instructions, within certain limits.
You may, on your own, work out a payment arrangement post-bankruptcy with your co-signer, or simply pay it, if possible. There is no provision of the US Bankruptcy Code that forbids a post-discharge bankrupt from voluntarily paying a discharged debt.
Short of non-repayment, your co-signer will want to militantly check his or her credit report 6 months after your discharge to ensure that your bankruptcy is not being reported inaccurately to his or her credit report.
If it is, the co-signer will need to follow the instructions on the credit report to file a dispute with the credit bureau.
CO-SIGNERS AND BANKRUPTCY: THE BOTTOM LINE
An experienced bankruptcy attorney will discuss the impact of your bankruptcy filing upon your co-debtors with you at your initial bankruptcy consultation appointment, unless you fail to reveal the existence of co-debtors to your attorney.
Attorney Walter Metzen has represented thousands of consumers in Chapter 7 and Chapter 13 bankruptcy cases in Michigan. A Board Certified Bankruptcy Expert, Attorney Metzen has successfully obtained discharges of debt in bankruptcy for his clients for over 28 years.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best course of action when filing a Chapter 7 or Chapter 13 bankruptcy in Michigan.
We will ensure that you have the information you need to make the best decision you can for yourself and for any co-debtors.